1. Americas Exhausted Paradigm: Macroeconomic Causes of the Financial Crisis & Great Recession Thomas Palley E-mail:mail@thomaspalley.com

2. Thinking about the Crisis Conventional wisdom = the crisis is due to regulatory and market failure. But what if the economy needed a bubble to ensure growth & full employment?

3. Figure 1. Macroeconomic factors and the economic crisis. Macroeconomic Factors Flawed US growth modelFlawed US model of global economic engagement

4. US Growth Model - 1 Old Post WW II growth model based on (1) Full employment (2) System in which wages grew with productivity Created created a virtuous circle of growth After 1980 created new growth model (1) retreat from commitment to full-employment (2) Severed productivity growth – wage link. (3) Instead, relied on debt & asset price inflation to fuel demand.

5. US Growth Model - 2 Features of new model visible in all business cycles post-1980 Business cycles of Reagan, Bush pere, Clinton, & Bush fils have common features that make them remarkably simialr.

6. Table 1. Manufacturing employment by business cycle, Oct. 1945 – Jan. 1980. TroughEmployment (Millions) PeakEmployment (Millions) Change Oct. 194512.5Nov.194814.31.8 Oct. 194912.9Jul.195316.43.5 May 195415.0Aug.195715.90.9 Apr. 195814.5Apr.196015.71.2 Feb. 196114.8Dec.196918.63.8 Nov.197017.0Nov.197318.81.8 Mar.197516.9Jan.198019.32.4

7. Table 2. Manufacturing employment by business cycle, July 1980 – Dec. 2007. TroughEmployment (Millions) PeakEmployment (Millions) Change July 198018.3July 198118.80.5 Nov.198216.7July 199017.71.0 Mar.199117.1Mar.200116.9-0.2 Nov.200115.8Dec.200713.8-2.0

8. Table 3. The US goods trade deficit by business cycle peaks, 1960 – 2007. Peak yearTrade deficit ($ millions) GDP ($ billions) Trade deficit/ GDP (%) 19603,508526.40.7 196991984.60.0 19731,9001,382.70.1 1980-25,5002,789.5-0.9 1981-28,0233,128.4-0.9 1990-111,0375,803.1-1.9 2001-429,51910,128.0-4.2 2007-819,37313,807.5-5.9

10. Table 5. Distribution of family income by household income rank, 1947 – 2006. Source: Mishel et al. (2008) and authors calculations. YearBottom 40% Next 40% Next 15% Top 5% 194716.9%40.1%25.5%17.5% 197317.441.525.615.5 197917.041.626.115.3 198915.240.226.717.9 200014.138.126.621.1 200613.538.027.021.5

12. The Neo-liberal Policy Box WORKERS Globalization Abandonment of full employment Small Government Labor Market Flexibility

13. Table 6. Household debt/GDP and Non-financial corporation debt/GDP ratios by business cycle peaks, 1948 – 2007. Source: FRB Flow of Funds Accounts and authors calculations. Year GDP ($ billions) Household debt (H) ($ billions) H/GDP Non-financial Corp debt (C) ($ billions) C/GDP 1960526.4215.60.41201.00.38 1969984.6442.70.45462.00.47 19731,382.7624.90.45729.50.53 19813,128.41,507.20.481662.00.53 19905,803.13,597.80.623,753.40.65 200110,128.07682.90.766,954.00.69 200713,807.513,765.11.0010,593.70.77

14. Table 7. Household debt service and financial obligations as percent of disposable income (DSR) by business cycle peaks, 1981 – 2007. Source: Federal Reserve Board. Year1980.q31991.q32001.q42007.q4 DSR10.9%12.0%13.4%14.3%

15. Table 8. CPI inflation and home price inflation based on the S&P/Case-Shiller National Home Price Values Index Period1987.q1 – 1990.q1 1990.q1 – 1995.q1 1995.q1 – 2001.q1 2001.q1 – 2006.q1 Home price inflation (%) 6.70.65.710.9 Average CPI Inflation (%) 4.53.52.5%2.5 Excess house inflation (%) 2.2-2.93.28.4

16. Table 9. Personal saving rate (PSR). Source: Economic Report of the President, table B.30 (2009). Period19601969197319801981199120012007 PSR (%) 7.37.810.510.010.97.31.80.6

17. US Growth Model - 3 New growth model intrinsically unsustainable because relies on (1)Squeezing incomes of workers (2)Squeezing household saving rates (3)Raising debt levels (4)Asset price inflation.

18. Flawed Global Engagement - 1 Flawed global economic engagement policy created a triple hemorrhage: (1)Leakage of spending via imports (2)Leakage of jobs via offshore outsourcing and shifting of production. (3)Leakage of investment.

19. Flawed Global Engagement- 2 (1) Replaced balanced trade with huge trade deficits. (2) Instead of promoting exports, created a global production zone from which American firms could export to the US & from which could buy cheaper inputs.

20. Stage 1: NAFTA

21. Table 10. US goods trade balance with Mexico before & after NAFTA ($ billions) Source: Census Bureau. 199119921993199419951996200020052007 2.15.41.71.3-15.8-17.5-24.5-49.7-74.6

22. Stage 2: East Asian Financial Crisis & Strong Dollar Policy

23. Table 11. US goods trade balance ($ billions). Source: Census Bureau. 199519961997199819992000 -174.2-191.0-198.4-248.2-347.8-454.7

24. Table 12. US goods trade balance with Pacific rim countries ($ billions). Source: Census Bureau. 199519961997199819992000 -108.1-101.8-121.6-160.4-186.0-215.4

25. Stage 3: China PNTR

26. Table 13. US goods trade balance with China before & after PNTR ($ billions) Source: Census Bureau. 199819992000200120022003200420052007 -56.9-68.7-83.9-83.1-103.1-124.1-161.9-201.5-256.2

27. The Chickens Come Home to Roost Post-1980 created a growth model that needed bubbles The weaker the economy became the larger the needed bubble. Flawed global engagement accelerated economic weakeing. That meant we needed the mother of bubbles (housing). Full logic took a long time to emerge & the chickens only came home to roost in last cycle.

28. Table 14. US manufacturing employment (millions). Source: Economic Report of the President, Table B-46 (2009). 199719981999200020012002200320052007 17.4217.5617.3217.2616.4415.2614.5114.3213.88

29. Where Next? - 1 Ultimate cause of the crisis is our flawed macroeconomic pradigm. Fixing regulation & incentives can limit financial excess BUT it does not address underlying macroeconomic problem. We need paradigm change.

30. Where Next? - 2 Problem = no understanding of the problem. Obama administration looking to maintain the system rather than change it. Will succed in stabilizing the system but likely result will be stagnation because the paradigm is burnt out.