A Simple Model of Financial Crises: Household Debt, Inequality and Housing Wealth
45 Pages Posted: 24 May 2018
Date Written: April 1, 2018
In the aftermath of the 2008 financial crisis, the GDPs of the US and the eurozone have grown astonishing slowly and have not yet recovered their pre-crisis rates, as of 2016. Here, we argue that, in order to escape further sluggish growth, we need to diagnose the present ailments as rooted in the characteristics of growth regimes prior to the crisis. To do so, we use key stylized facts to develop a simple stock-flow-consistent (SFC) macroeconomic model that incorporates a financial and a real economic circuit, household credit and distributive dynamics. As such, it is able to trace stylized growth patterns over the last decades, taking non-linear dynamics into account. The model leads to three main findings. First, positive feedback between financialization and rising income inequality leads, over time, to credit-burdened growth (the Perpetual Money Machine regime). Second, households either consume or speculate with the newly created money giving rise to a bubble, which endogenously bursts in a financial crisis. The GDP collapses, asset prices fall, and the private sector deleverages. Third, in the after-crisis period, the government has room to stabilize GDP temporarily by acting as a borrower of last resort. In so doing, we find that recovering a solid growth requires the government to observe the golden wage rule, namely to re-couple wages and output.
Keywords: Financial Crises, Collateral, Credit Creation, Housing Wealth
JEL Classification: G01, E64, E51
Suggested Citation: Suggested Citation