It appears the latest issue of Money magazine is devoting attention to University of Chicago economist Raghuram Rajan because Rajan “stands out as one of the few economists who cite income inequality” as a root cause of the financial crisis.
As Money‘s David Futrelle notes, “That’s hardly the type of theory you’d expect to hear from an economist at the University of Chicago, a bastion of free-market thinking.”
Read the three pages of transcribed interview, though, and you’ll get the sense that Rajan’s ideas are not as remarkable as Futrelle’s commentary suggests.
Many blame the financial crisis on housing. But you’ve suggested the real estate bubble itself was a bungled political attempt to deal with the real root cause: rising income inequality. Can you explain?
In the 1980s we saw a widening of income inequality. Typically the political reaction to that is to redistribute wealth. But in the ’80s and ’90s there was a sense that we’d had too much redistribution, too much welfare. So you had to find something else, and housing fit the bill for both political parties. The Democrats thought it was wonderful to support home ownership for the poor, their natural constituents. The Republicans figured property owners would eventually vote Republican.
Note that Rajan focuses on the political element of this issue. Politicians wanted to “do something” about rising income inequality. Limiting analysis to this single exchange, it might be fairer to say that Rajan is saying politicians’ counterproductive reaction to income inequality is a root cause of the financial crisis, not the income inequality itself.
But it’s possible to read those two paragraphs and think, “If housing was the wrong approach, perhaps politicians should have stuck with the wealth redistribution.” What does Rajan think about that option?
What can government do to reduce inequality?
In the long run, redistribution doesn’t work.
Perhaps Rajan is a fan of stimulus spending to get the economy out of its current sluggishness?
The standard Keynesian economic response to stimulate the economy is with government spending and low rates, right?
This is where I depart from economists like [New York Times columnist] Paul Krugman, who has been emphasizing the need to pump up demand, whether it be through monetary policy or through fiscal policy. My view is that it’s not all about demand. In the jargon of economists, we don’t just have a cyclical problem, we have a structural problem. There’s a fundamental mismatch between the skills of the labor force and the kind of jobs the economy is creating.
Pumping up demand again may create an illusion of growth, but until we fix the underlying problems we will not have sustainable growth. The Fed can keep rates low for a very long time, and pump up asset prices and create new lending booms, but if the underlying dynamics aren’t sustainable, we’ll end up creating an eventual bust.
Let’s see: Politicians created, or at least exacerbated, a problem. Wealth redistribution won’t solve it. Krugman is wrong.
It doesn’t sound as if Rajan’s views are all that radical.