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Inequality, Leverage and Crises: Theory and Evidence Revisited

Rajan points to rising income inequality as a root cause of the recent financial crisis through high household leverage. The Rajan hypothesis has ignited debate over the relationship between inequality, leverage and crises. Kumhof, Ranciere, and Winant prove the validity of this hypothesis with a theoretical formulation, but empirical studies provide mixed evidence using different samples and estimators. To clarify this controversy, we re‐examine the issue by using the same data as in the literature and provide additional evidence after taking into account the role of asset bubbles and policy interventions. Our regression is based on a new tractable theoretical model that is supported by key stylised facts, and all our analyses confirm the existence of the inequality–leverage–crisis nexus.