The expansion of financial services in an economy can reduce income inequality — but beyond a certain point it tends to have the opposite effect, according to the International Monetary Fund (IMF).
Better access to banking and credit can help close income gaps by allowing people to save and invest more, the Washington-based fund said in a staff discussion note by authors including Martin Cihak and Ratna Sahay. But once the financial sector surpasses a certain size threshold relative to the economy, its growth typically exacerbates inequality, study said.
Bigger income disparities are “associated with greater financial risks,” it said, and they “tend to be accompanied by higher growth in credit.” The Fund cited the example of the US, where too much credit — including to lower-income households — contributed to the 2008 crash. And it said that “crises, in turn, lead to higher default rates, making lower-income households worse off.”
Income inequality has emerged as one of the major economic problems of the era. Democratic presidential candidates in the US have put the issue at the center of their campaigns.
, and it’s contributed to violent protests from Latin America to the Middle East.
“We learned that excessive inequality hinders growth. It hollows out a country’s foundation,” IMF Managing Director Kristalina Georgieva said in a speech Friday to present the study’s findings. “It erodes trust in society. It erodes trust in institutions. And it can fuel populism, and it can fuel political upheaval.”
The IMF study also found that inequality tends to fall further when women gain greater access to financial services. And it said that good regulation is key to “reining in excessive growth of the financial sector.”