A Simple Model of Financial Crises: Household Debt, Inequality and Housing Wealth

45 Pages Posted: 24 May 2018

See all articles by Richard Senner

Richard Senner

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss National Bank - Financial Stability

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute; Southern University of Science and Technology; Tokyo Institute of Technology

Date Written: April 1, 2018

Abstract

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

Senner, Richard and Sornette, Didier, A Simple Model of Financial Crises: Household Debt, Inequality and Housing Wealth (April 1, 2018). Available at SSRN: https://ssrn.com/abstract=3176904 or http://dx.doi.org/10.2139/ssrn.3176904

Richard Senner (Contact Author)

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

ETH-Zentrum
Zurich, CH-8092
Switzerland

Swiss National Bank - Financial Stability ( email )

Boersenstrasse 15
Zurich, CH-8022
Switzerland

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Southern University of Science and Technology

1088 Xueyuan Avenue
Shenzhen, Guangdong 518055
China

Tokyo Institute of Technology

2-12-1 O-okayama, Meguro-ku
Tokyo 152-8550, 52-8552
Japan

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