How income inequality contributed to the Great Recession
This article is fascinating. Like so many things from America, it seems to have got there first. It tells us:
“The idea that the Great Recession of 2008 may have been caused not just by careless banking but also social inequality is currently all the rage among macroeconomists.
Much of the impetus for the current debate stems from the widely discussed 2010 book Fault Lines, written by Raghuram Rajan, a former chief economist of the International Monetary Fund. Rajan argues that many lower- and middle-class consumers in the United States have reacted to the stagnation of their real incomes since the early 1980s by reducing saving and increasing debt. This has temporarily kept private consumption and thus aggregate demand and employment high, but also contributed to the creation of the credit bubble which eventually burst.
In Rajan’s view, a large portion of the blame for this falls on misguided government policies, which promoted the expansion of credit to households. But the “Rajan hypothesis” also contradicts the dominant textbook theories of consumption, which see no link between persistent income inequality and aggregate private consumption, and hence no need for government action stimulating consumption demand and jobs in response to higher inequality.
These theories, known as the permanent income or life-cycle hypotheses, are based on the assumption that consumers form rational expectations about their long-term income. Short-term fluctuations of income due to, say, unexpected job loss, or lower than average stock market returns, have only a limited impact on current consumption since households expect them to be only temporary. According to this view, households can insure against windfall losses through efficient credit markets and “smooth” their consumption over the longer term.”
The British economy has allowed people to expect this long term certainty by growing metronomically at 2 -2.5% a year for the last 50 years. The key question is if this is now over will the opportunity for people to ride out the type of short term fluctuations identified above continue? If not then inequalities will grow as credit dries up. We can already see this happening in generational terms with young people without private backing daunted by university debt and effectively debarred from the mortage market. This will have major implications for young people seeking to exercise choices about living and working in rural England, where the extremes around these issues are exacerbated by sparsity.