Home > The Economics Profession > Inequality and the current crises

Inequality and the current crises

from David Ruccio

Mainstream economists (like Brad DeLong) can’t seem to find any connections between growing inequality and the current crises. But it’s not a problem for Federal Reserve Board Governor Sarah Bloom Raskin.

Yes, this is the same Raskin who recently decided to look beyond capitalism for a solution to the current crises. In an extension of those remarks, she set out to examine how “economic marginalization and financial vulnerability, associated with stagnant wages and rising inequality, contributed to the run-up to the financial crisis and how such marginalization and vulnerability could be relevant in the current recovery.”

Here’s her argument in a nutshell:

at the start of this recession, an unusually large number of low- and middle-income households were vulnerable to exactly the types of shocks that sparked the financial crisis. These households, which had endured 30 years of very sluggish real-wage growth, held an unusually large share of their wealth in housing, much of it financed with debt. As a result, over time, their exposure to house prices had increased dramatically. Thus, as in past recessions, suffering in the Great Recession–though widespread–was most painful and most perilous for low- and middle-income households, which were also more likely to be affected by job loss and had little wealth to fall back on.

Moreover, I am persuaded that because of how hard these lower- and middle-income households were hit, the recession was worse and the recovery has been weaker. The recovery has also been hampered by a continuation of longer-term trends that have reduced employment prospects for those at the lower end of the income distribution and produced weak wage growth.

This is a remarkable thesis, better than 99 percent of what we have heard from mainstream economists throughout this sorry spectacle (although Raskin does stumble a bit in repeating the mainstream penchant to invoke “technological change that favors those with a college education and globalization” as the causes of inequality).

And Raskin is well aware of how novel her thesis is, at least in mainstream circles:

To be clear, my approach of starting with inequality and differences across households is not a feature of most analyses of the macroeconomy, and the channels I have emphasized generally do not play key roles in most macro models. The typical macroeconomic analysis focuses on the general equilibrium behavior of “representative” households and firms, thereby abstracting from the consequences of inequality and other heterogeneity across households and instead focusing on the aggregate measures of spending determinants, including current income, wealth, interest rates, credit supply, and confidence or pessimism. In certain circumstances, this abstraction might be a reasonable simplification. For example, if the changes in the distribution of income or wealth, and the implications of those changes for the overall economy, are regular features of business cycles, then even an aggregate model without an explicit focus on distributional issues would capture those historical regularities.

However, the narrative I have emphasized places economic inequality and the differential experiences of American families, particularly the highly adverse experiences of those least well positioned to absorb their “realized shocks,” closer to the front and center of the macroeconomic adjustment process. The effects of increasing income and wealth disparities–specifically, the stagnating wages and sharp increase in household debt in the years leading up to the crisis, combined with the rapid decline in house prices and contraction in credit that followed–may have resulted in dynamics that differ from historical experience and which are therefore not well captured by aggregate models. How these factors have interacted and the implications for the aggregate economy are subject to debate, but I have laid out some possible channels through which there could be effects and that I believe represent some particularly fruitful areas for continued research.

I’m certainly not going to hold my breath—and I doubt Raskin is, either—until mainstream economists decide to actually pursue these lines of research.

  1. May 1, 2013 at 7:44 pm

    A chart of M2 vs M1 for the USA shows that the last 3 recessions (post Nixon’s closing the gold window) followed several years in which M1 (spending money ) remained constant or shrank while M2 (savings) increased.

    Currently corporations are sitting on mountains of “cash”. This is money that was created as someone else’s debt and needs to be spent to retire that debt. BUT… the avers aren’t spending it so the borrowers can earn it. The savers are only lending it so the borrowers have to borrow it a SECOND TIME to pay off the original debt.

    Now, we have to borrow from Peter to pay Paul and vice versa FOREVER, on time and without fail. Any time the volume of borrowing shrinks or slows down for ANY REASON, defaults are mathematically (unjustly) triggered.

    The only escape is for the rich to SPEND their savings.

    I propose that the cause of recessions, massive defaults and money system collapse is the design of the money system itself, specifically “indefinite savings” that are not available to be earned on time (or ever) to eliminate the debt that created that money.

    Therefore, income inequality would be expected to result in periodic crashes of the system with massive defaults. This dynamic is completely ignored by economists.

    As always I invite all attempts to refute my theorem.

    peer-reviewed paper at the WEA
    http://peemconference2013.worldeconomicsassociation.org/?paper=proposed-new-metric-the-perpetual-debt-level

    full written analysis:
    http://paulgrignon.netfirms.com/MoneyasDebt/Analysis_of_Banking.html

    animated presentation:
    http://paulgrignon.netfirms.com/MoneyasDebt/twicelentanimated.html
    Paul

  2. Ken Zimmerman
    May 2, 2013 at 5:21 am

    In the words of Everlast, who obviously mainstream (and not likely even non-mainstream) economists have never heard:

    I’ve seen a rich man beg, I’ve seen a good man sin
    I’ve seen a tough man cry, I’ve seen a loser win
    And a sad man grin, I heard an honest man lie
    I’ve seen the good side of bad and the downside of up
    And everything between
    I licked the silver spoon, drank from the golden cup
    And smoked the finest green
    I stroked the fattest dimes at least a couple of times
    Before I broke their heart
    You know where it ends, yo, it usually depends on where you start

    And he’s just a high school drop out.

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