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Is Income Inequality the Cause of the Recession?

October 11, 2011

We know that the mortgage crisis contributed to our economic problems, but is that the only cause? No.

First, Some researchers are now saying that a major factor to our economic problems is the economic division between the rich and poor — the rich are getting richer and the poor are getting poorer. And now the wealthy an astronomical amount of money compared to everyone else.

A September 2010 report “Income Inequality and the Great Recession“by the U.S. Congress Joint Economic Committee states that

Income inequality may be part of the root cause of the Great Recession. Stagnant incomes for all but the wealthiest Americans meant an increased demand for credit, fueling the growth of an unsustainable credit bubble. Bank deregulation allowed financial institutions to create new exotic products in which the ever‐richer rich could invest. The result was a bubble‐based economy that came crashing down in late 2007.

Moreover, “[p]eaks in income inequality preceded both the Great Depression and the Great Recession, suggesting that high levels of income inequality may destabilize the economy as a whole.”

Robert Reich agrees that income inequality is a major contributing factor to our economic problems. He argues that the  “When most of the gains from economic growth go to a small sliver of Americans at the top, the rest don’t have enough purchasing power to buy what the economy is capable of producing.” I find this argument plausible because a recession isn’t caused by money disappearing. Roughly the same amount of money exists now as existed 10 years ago. The problem is that most of us no longer have money to buy anything any longer because those who have most of it are keeping it for themselves.

Second, there are other potential causes of the recession. According to Jacob Weisberg, the following could also be major contributing factors:

  1. The housing bubble burst.
  2. The Federal Reserve kept interest rates too low and therefore encouraged reckless lending.
  3. A lack of bank regulation.
  4. Global savings imbalances.
  5. Corruption and misjudgment of credit rating agencies.
  6. The lack of transparency about the risk involved with banks.
  7. Excessive reliance on mathematical models.
  8. Excessive compensation and too-big-to-fail gurantees.
  9. The former Treasury Secretary Hank Paulson’s inadequate initial responses to the crisis

I’m surprised that Weisberg didn’t mention the failure of accounting auditors, who were blamed for failing to identify the corruption of many companies in the past (such as Enron and WorldCom). We rely on them to make sure businesses stay honest.

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