Does Greater Inequality Lead to More Borrowing: New Evidence from Household Data

We combine household data on debt during 2001-2012, regional variation in inequality, and a novel imputation procedure to show that low-income households in high-inequality regions accumulated less debt relative to income than similar households in lower-inequality regions. These results are robust across subsamples and within debt categories, with the strongest effects in mortgage debt. To determine if these quantity movements are driven by supply or demand we examine measures of credit cost and access with data on individual mortgage applications. We find that as inequality increases, low-income households are more likely to be denied credit, more likely to be charged a high interest rate, have to travel further to lender branches, and are less likely to have a new branch opened in their neighborhood. We argue that these patterns are consistent with local inequality differentially affecting the supply of credit to low- and high-income households. We propose a simple model to rationalize these findings that hinges on lenders using a household’s relative position in the local income distribution to infer the underlying quality of applicants. Higher inequality allows lenders to more easily discern borrower quality and so channel relatively more credit toward higher-income applicants. These results highlight a novel channel through which changes in inequality can have significant and differential economic effects on household leverage.