MacroScope

Inequality and the crisis: the other missing link of macroeconomics?

Ever since an epic financial crisis hit the United States in 2008, mainstream economists, most of whom utterly failed to foresee the oncoming train wreck, have been scrambling to introduce a financial sector dimension to their models. It was a conventional approach that detached the study of financial stability from macroeconomic variables, the narrative goes, that prevented the experts from seeing the build-up of an unsustainable housing bubble that, when it crashed, took down the economy down with it.

Research by James Galbraith, professor of public policy at the University of Texas at Austin, suggests finance is only one blind spot for the economics profession. Another key and increasingly relevant factor in the public debate that has been largely ignored is the issue of inequality. The first chapter of Galbraith’s latest book, “Inequality and Instability,” begins like this:

In the late 1990s, standard measures of income inequality in the United States – and especially of the income shares held by the very top echelon – rose to levels not seen since 1929. It is not strange that this should give rise (and not for the first time) to the suspicion that there might be a link, under capitalism, between radical inequality and financial crisis.

The link, of course, runs through debt. For those with a little money, it is said, the spur of invidious comparison produces a want for more, and what cannot be earned must be borrowed. For those with no money, made numerous by inequality and faced with exigent needs, there is also the ancient remedy of a loan. The urges and the needs, for bad and for good, are abetted by the aggressive desire of those with money to lend to those with less. They produce a pattern of consumption that at times appears broadly egalitarian; the rich and the poor alike own televisions and drive automobiles, and until recently in America members of both groups even owned their homes.

But the terms are rarely favorable; indeed, the whole profit in making loans to the needy lies in getting a return upfront. There will come a day, for many of them, when the promise to pay in full cannot be kept.

Economics, astrology and 2012 predictions

As the usual end-of-year predictions roll in, perhaps the safest bet was captured this tweet from Bajaji Sridharan:

Since everyone is making predictions for 2012, here’s my prediction — 90%+ of all the 2012 predictions will be wrong.

It was another way of expressing a sentiment eloquently phrased by the late economist John Kenneth Galbraith – and frequently quoted by Dallas Fed President Richard Fisher – on the commonalities between economics and the stars. Galbraith wrote:

from Global Investing:

Watch the bezzle

  Who is next? After the Madoff and Satyam scandals, rattled investors are looking anxiously over their shoulders for the next big financial fraud.   It is generally assumed that the downturn will expose more wrongdoings - but that doesn't mean people become more dishonest when the economy is sick. In fact, quite the opposite, according to John Kenneth Galbraith's definitive 1954 work "The Great Crash, 1929."   When it comes to embezzlement, it's all a question of how visible the "bezzle" is, he argues.   Galbraith's 200-page history of the world's biggest boom-and-bust has stormed back into the bestseller lists in recent months, giving modern-day readers a glimpse of how speculative markets became divorced from reality 80 years ago and the hazards this created.   His words are as relevant as ever:   At any given time there exists an inventory of undiscovered embezzlement in - or more precisely not in - the country's businesses and banks. This inventory - it should perhaps be called the bezzle - amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.   (Reuters photo: Disgraced financier Bernard Madoff is escorted by police as he departs U.S. Federal Court after a hearing in New York, January 5, 2009)