Saturday, January 16, 2010

The grand cause of the economic crisis

The grand cause of the economic crisis, according to French economist Pierre Larrouturou (Le Monde, Jan. 13, 2010) and Raghuram Rajan (University of Chicago, cited in The New Yorker, Jan. 11, 2010), is that since the end of the 70s, salary income has increased slower than the cost of living, triggering an increase in the use of credit:

"Rajan argues that the initial causes of the breakdown were stagant wages and rising inequality. With the purchasing power of many middle-class households lagging behind the cost of living, there was an urgent demand for credit. The financial industry, with encouragement from the government, responded by supplying home-equity loans, subprime mortgages, and auto loans. (Notwithstanding the government's involvement, this is ultimately a traditional Chicago argument: in response to changing economic circumstances, the free market provided financial products that people wanted.) The side effects of unrestrained credit growth turned out to be devastating--a possibility that most economists had failed to consider."
John Cassidy, The New Yorker, Jan. 11, 2010.

John Cassidy makes here an important point within the parenthesis: the government, as any individual, is part of the market and reacts, as rationally as it can, to the course of the economy. More than that; the government did not prevent the course of the free market and even facilitated it by allowing easier access to credit. Simply single-handling the government as the source of the problem seems then to fall short of the whole story.

But what caused the start of the imbalance between cost of living and income at the end of the 70s and disrupted the Keynesianism equilibrium of the post-War years? Neither of the two articles explain this. Was it the oil crisis? The rise of Reaganism? A combination of both?

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