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America's exhausted paradigm: Macroeconomic causes of the financial crisis and great recession

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  • Palley, Thomas I.

Abstract

This paper traces the roots of the current financial crisis to a faulty U.S. macroeconomic paradigm. One flaw in this paradigm was the neo-liberal growth model adopted after 1980 that relied on debt and asset price inflation to drive demand in place of wage growth. A second flaw was the model of U.S. engagement with the global economy that created a triple economic hemorrhage of spending on imports, manufacturing job losses, and off-shoring of investment. Financial deregulation and financial excess are important parts of the story, but they are not the ultimate cause of the crisis. These developments contributed significantly to the housing bubble but they were a necessary part of the neoliberal model, their function being to fuel demand growth by making ever larger amounts of credit easily available. As the neoliberal model slowly cannibalized itself by undermining income distribution and accumulating debt, the economy needed larger speculative bubbles to grow. The flawed model of global engagement accelerated the cannibalization process, thereby creating need for a huge bubble that only housing could provide. However, when that bubble burst it pulled down the entire economy because of the bubble's massive dependence on debt. The old post-World War II growth model based on rising middle-class incomes has been dismantled, while the new neoliberal growth model has imploded. The United States needs a new economic paradigm and a new growth model, but as yet this challenge has received little attention from policymakers or economists.

Suggested Citation

  • Palley, Thomas I., 2009. "America's exhausted paradigm: Macroeconomic causes of the financial crisis and great recession," IPE Working Papers 02/2009, Berlin School of Economics and Law, Institute for International Political Economy (IPE).
  • Handle: RePEc:zbw:ipewps:022009
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    Cited by:

    1. Thomas Goda, 2013. "The role of income inequality in crisis theories and in the subprime crisis," Working Papers PKWP1305, Post Keynesian Economics Study Group (PKSG).
    2. Lino Sau, 2015. "Debt deflation worries: a restatement," Review of Keynesian Economics, Edward Elgar Publishing, vol. 3(3), pages 279-294, July.
    3. Gustav A. Horn & Katharina Dröge & Simon Sturn & Till van Treeck & Rudolf Zwiener, 2009. "Von der Finanzkrise zur Weltwirtschaftskrise (III)," IMK Report 41-2009, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    4. Barry Z. Cynamon & Steven M. Fazzari, 2013. "Inequality and Household Finance during the Consumer Age," Economics Working Paper Archive wp_752, Levy Economics Institute.
    5. Laura Carvalho & Corrado Di Guilmi, 2014. "Income inequality and macroeconomic instability: a stock-flow consistent approach with heterogeneous agents," CAMA Working Papers 2014-60, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    6. Lino Sau, 2015. "Do the International Monetary and Financial Systems Need More Than Short-Term Cosmetic Reforms?," International Journal of Political Economy, Taylor & Francis Journals, vol. 44(4), pages 325-340, October.
    7. Rudiger von Arnim & Daniele Tavani & Laura Barbosa de Carvalho, 2012. "Globalization as coordination failure: A Keynesian perspective," Working Papers 1202, New School for Social Research, Department of Economics.
    8. David Cayla, 2013. "European Debt Crisis: How a Public Debt Restructuring Can Solve a Private Debt Issue," Journal of Economic Issues, Taylor & Francis Journals, vol. 47(2), pages 427-436.
    9. Thomas I. Palley, 2013. "Europe´s crisis without end: The consequences of neoliberalism run amok," IMK Working Paper 111-2013, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    10. Lawson, Cornelia & Soós,Sándor, 2014. "A Thematic Mobility Measure for Econometric Analysis," Department of Economics and Statistics Cognetti de Martiis. Working Papers 201408, University of Turin.
    11. Thomas I. Palley, 2013. "Gattopardo economics: the crisis and the mainstream response of change that keeps things the same," European Journal of Economics and Economic Policies: Intervention, Edward Elgar Publishing, vol. 10(2), pages 193-206.
    12. Peter Skott, 2013. "Increasing Inequality and Financial Instability," Review of Radical Political Economics, Union for Radical Political Economics, vol. 45(4), pages 478-488, December.
    13. George Irvin, 2011. "Forum 2011," Development and Change, International Institute of Social Studies, vol. 42(1), pages 154-182, January.
    14. Barry Cynamon & Steven Fazzari & Mark Setterfield, 2013. "How the Great Moderation Became a (Contained) Depression and What to Do About It," Working Papers 1303, Trinity College, Department of Economics.
    15. Peter Skott, 2011. "Heterodox macro after the crisis," UMASS Amherst Economics Working Papers 2011-23, University of Massachusetts Amherst, Department of Economics.
    16. repec:mes:postke:v:35:y:2012:i:2:p:187-213 is not listed on IDEAS
    17. Thomas Goda, 2013. "Changes in income inequality from a global perspective: An overview," Working Papers PKWP1303, Post Keynesian Economics Study Group (PKSG).
    18. Hassan Bougrine, 2012. "Fiscal austerity, the Great Recession and the rise of new dictatorships," Review of Keynesian Economics, Edward Elgar Publishing, vol. 1(0), pages 109-125.
    19. Angel Asensio, 2010. "Macroeconomic trouble and policy challenges in the wake of the financial bust," Working Papers halshs-00496921, HAL.
    20. Eckhard Hein & Achim Truger, 2012. "Finance-dominated capitalism in crisis—the case for a global Keynesian New Deal," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 35(2), pages 187-213.
    21. Rastislav Funta, 2011. "Economic Law and Economic Crisis. Where Do We Go From Here? Economic, Legal and Political Dimension," DANUBE: Law and Economics Review, European Association Comenius - EACO, issue 1, pages 65-71, March.
    22. Robert A. Blecker, 2013. "Economic Stagnation in the United States: Underlying Causes and Global Consequences," Working Papers 2013-16, American University, Department of Economics.

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