The paper studies how high household leverage and crises can be caused by changes in the income distribution. Empirically, the periods 1920–1929 and 1983–2008 both exhibited a large increase in the income share of high-income households, a large increase in debt leverage of low- and middle-income households, and an eventual financial and real crisis. The paper presents a theoretical model where higher leverage and crises are the endogenous result of a growing income share of high-income households. The model matches the profiles of the income distribution, the debt-to-income ratio and crisis risk for the three decades preceding the Great Recession.

We propose a simple quantitative method to linearize around the risky steady state of a small open economy. Unlike when the deterministic steady state is used, the net foreign asset position is well defined. We allow for stochastic income and stochastic interest rate.