Paul Krugman makes the distinction between two explanations for the debt buildup that preceded the 2008 financial crisis. One gets the Stiglitz label: rising inequality induced households whose incomes were stagnating to take on more debt than they should have. The other gets Minsky’s: financial institutions became less cautious and government regulation waned. He distances himself from Obama, who signed onto the inequality story.
But surely it’s not either/or, and this is not a matter of slicing the (debt) pie either. These stories are about two different sectors of the economy. Household debt certainly accumulated unsustainably during the 1990s and 2000s. The current desire on the part of households to deleverage or refrain from the borrowing habits of earlier times has played an important role in the stubbornness of slow growth and high unemployment. But the financial panic itself was a recoil from a stupendous excess of leverage in the financial sector. Deregulation itself was leveraged via clever engineering and finely-tuned incentive structures to propagate enormous systemic risk in order to secure a maximum of private yield. And the explosion of top incomes in finance played a big role in the rise of inequality among the 1%.
Of course, the two sectors were not ensconced in isolated universes, uncontaminated by one another. The mortgage frenzy was made possible by the musical chairs game being played by finance, where risk was always being offloaded to someone else. (That “always” is impossible, of course.) Conversely, household debt was raw material for the production of opaque financial instruments, which could be priced to yield bonuses for their creators.
And finally there’s the structural dimension. This is always difficult for economists to cope with since, along the structure-agency continuum, economics is nearly all agency. But still: all major deficit countries experienced a massive debt buildup, while surplus countries did not. Causation is messy, to say the least. Certainly a big chunk of it goes from private behavior to public outcomes; without all that household borrowing the huge current account deficit of the US, and the smaller deficits of the European peripherals, could not have materialized. But causation also goes the other way. Trade deficits mean lost jobs. Consumption never falls pari passu with income. Meanwhile, the political economy of deficit countries pushes government to tolerate more debt, either the private sector’s or its own, to avoid contraction. As far as the US was concerned, the economic pain of trade deficits was not distributed evenly; it was concentrated in particular industries, regions and occupations, which contributed to the Stiglitz—inequality—factor.
If I were Obama’s speechwriter, I would say something like this: America’s economic pre-eminence and its key currency status has enabled it to become an unsustainable deficit country. This has fed the inequality that has made our society so much coarser and unjust. And this inequality, the ability of an economic elite to prosper while the rest of us languish, has undermined the political will to make the changes that need to be made if America is to prosper again.
And if I wrote that, I wouldn’t be Obama’s speechwriter much longer.