Excess Savings, Monetary Policy, Macroprudential Policy and Financial Crises​​

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​The Roots in Rising Inequality

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Over recent decades, income has become increasingly concentrated among the top 1% of earners, while the bottom 99% have seen their share shrink. This growing divide creates a fundamental economic imbalance because these groups spend and save very differently. The bottom 99% typically spend most of their income on goods and services, while the top 1% save a much larger portion of theirs. As more wealth accumulates at the top, overall consumption in the economy weakens while excess savings grow - what economists call "underconsumption" and "savings glut."

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How Excess Savings and Underconsumption Weaken the Economy

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When the majority of consumers have less to spend, businesses face weaker demand for their products. This makes companies reluctant to invest in productive assets like factories, equipment, and technology. With fewer good opportunities for real investment, the excess savings generated by the wealthy have nowhere productive to go. This creates the conditions for "secular stagnation" - a persistent state of weak economic growth, low inflation, and chronically low interest rates that has characterized many advanced economies in recent decades.

 

The Flood into Financial Assets

 

These excess savings are stored in stocks, bonds, and loans because there aren't enough attractive real investments to absorb them all. Importantly, all financial assets represent someone else's liability. The mortgages, car loans, and credit card debt of the bottom 99% effectively become the financial assets of the top 1%. This creates a dangerous symmetry where rising inequality simultaneously increases both savings and debt levels in the economy.

 

Monetary Policy's Temporary Fix

 

Central banks catalyze debt production through cyclical tools such as lower interest rates and quantitative easing. While this debt-fueled spending can temporarily boost economic activity, it creates longer-term problems. Private debt grows faster than the overall economy, making households, businesses, and financial institutions increasingly vulnerable to economic shocks. We've essentially been treating the symptoms of inequality with debt, rather than addressing its root causes.​

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The Financial Crisis Trigger

 

Eventually, debt-driven growth reaches a breaking point. When overleveraged borrowers (households, firms, or banks) can no longer service their debts, defaults begin. Falling asset prices—triggered by panic selling—expose hidden risks in the financial system. Banks face liquidity shortages, credit markets freeze, and the economy spirals into crisis. The 2008 financial crisis is a prime example: excessive mortgage debt, securitization, and shadow banking leverage led to a catastrophic collapse.

 

The Limits of Macroprudential Policy

 

Policymakers have attempted to manage these risks through macroprudential regulations - rules designed to prevent excessive borrowing and lending. Measures like capital requirements for banks and loan-to-value limits aim to maintain financial stability. However, these regulations often have loopholes. Many corporate borrowers and non-bank lenders (like hedge funds and private equity firms) operate outside these rules, allowing risky leverage to continue building in the financial system.

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The Growth and Stability Dilemma

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Even if we perfectly implemented all financial regulations, we'd face a difficult dilemma. In an unequal economy where growth depends on debt-fueled consumption, restricting borrowing would slow economic activity. This leaves policymakers trapped between maintaining financial stability and supporting economic growth - with inequality making both goals harder to achieve simultaneously.

 

A Way Forward

 

Breaking this cycle requires moving beyond just managing its symptoms. We need policies that:

• Directly boost wages and worker bargaining power to strengthen consumption

• Implement progressive wealth taxes to reduce extreme concentration at the top

• Create new channels for savings to fund productive public investments

• Maintain prudent financial regulations while addressing their economic impacts

 

Only by tackling inequality itself can we escape the trap of weak demand, financial instability, and stagnant growth that currently plagues many advanced economies. The alternative is continuing the risky cycle of debt-fueled growth that inevitably leads to crisis.​​​​​​​