Is Rajan’s Hypothesis Confirmed by Empirical Evidence? A Critical Review

Abstract

Based on experience in the United States in recent decades, Rajan (2010) argues that there is an inequality-debt-crisis nexus, that is, income inequality may contribute to banking crises by stimulating the accumulation of household debt. Whether and to what extent Rajan’s hypothesis has been confirmed (or refuted) by the literature is investigated in this study. It is shown that the validity of Rajan’s theory depends on the level of strictness of the standards that are established to estimate the extent of agreement between theory and evidence. This conditional validity can be attributed to the multidimensional nature of the inequality-debt-crisis nexus, which is overlooked by Rajan. JEL Classification: D31, E51, G21, G51