Ostensible Financial Stability Caused by Wealth Inequality

Abstract

This article investigates ostensible financial stability of an economic sector caused by wealth inequality. When a sector is decomposed into two subsectors that possess a severe wealth inequality, the sector in entirety can look financially stable while the two subsectors have opposite extreme financially instability, one from excessive equity the other from lack thereof. The unstable subsector can result in further financial distress and even trigger a financial crisis. The market instability indicator, an early warning system derived from dynamical systems is used to analyze the subsectoral financial instability of the system. An extreme case analysis is provided to explain what financial instabilities can arise amid seemingly stable economy and positive outcomes.

Keywords: wealth inequality, financial stability, contagion, agent-based model

JEL Classification: C02, C65, G01