The paper assumes that weak labor bargaining power allows firms to set their markups in order to meet a target profit rate. At a low wage share, workers’ households are assumed to have limited flexibility in meeting financial goals, so household indebtedness tends to rise as the wage share falls. Rising indebtedness further lowers labor’s bargaining power, a phenomenon that was observed in the wave of financialization that began in the late 20th century. Thus, rising debt levels allow firms even greater freedom to raise their target profit rate.

The authors find that the dynamics can be either stable or unstable, with the potential for a self-reinforcing pattern of rising household indebtedness and falling wage share, consistent with trends in the US from the 1980s onward. The unstable cycle can be triggered by increased willingness by workers to incur debt and rising influence of household indebtedness on labor’s bargaining strength and income distribution.

The model can shed some light on widely-observed trends over recent decades regarding household indebtedness, inequality, and technological changes in the US, and potentially in other OECD countries.