7 September 2012

The following paper (pdf of full paper available here) provides an interesting analysis of causes of the Great Recession, analysis that we should ponder as we hear of Romney and Ryan's policies designed to greatly exaggerate current economic disparities: 

 Income inequality as a cause of the Great Recession? A survey of current debates 

 Till van Treeck & Simon Sturn, Geneva, 2012

 The recent debates about the role of income inequality in causing the “Great Recession” are surveyed along different dimensions. First, we review the controversy about the “Rajan hypothesis” for the United States. In his widely discussed book “Fault Lines” (2010), Raghuram Rajan argues that many U.S. consumers have reacted to the decline in their relative permanent incomes since the early 1980s by reducing saving and increasing debt. This has temporarily kept private consumption and thus aggregate demand and employment high, despite stagnating incomes for many households. But it also contributed to the creation of a credit bubble, which eventually burst, and a large current account deficit in the United States. We place the Rajan hypothesis in the context of competing theories of consumption, and survey the empirical literature on the effects of inequality on household behaviour beyond the largely anecdotal evidence provided in Rajan (2010). Second, we discuss the macroeconomic effects of income distribution in China and Germany, which both experienced pronounced declines in the share of wages and household income in national income, strong increases in personal inequality, rising personal saving rates, weak private consumption demand and strong improvements in the current account in the years before the Great Recession. Specifically, we argue that the ways in which consumers react to changes in relative income depend on such institutional factors as the deepness and regulation of the credit markets, the organisation of the labour market and the education and welfare systems, and the reactivity of monetary and fiscal policy to unemployment. We conclude that reducing inequality in these countries is crucial for overcoming macroeconomic instability and the global and European current account imbalances over the longer term.

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