It’s well known that the causes of the crash of 2008 and the subsequent Great Recession were a housing bubble and a financial crisis. But what were the long-term trends that brought the American economy to the edge of the cliff?
In the November 24th seminar hosted by SCEPA and The New School Economics Department, UCLA Professor of Urban Planning Matthew Drennan named income inequality as the decisive factor behind the crisis. In a talk based on his recently released book, “Income Inequality: Why it Matters and Why Most Economists Didn’t Notice,” Drennan argued that growing inequality directed income gains to the top sliver of the income distribution, leaving middle-class workers experiencing stagnant or falling incomes. To keep up with consumption, these households took on unsustainable debt, often leveraged through home equity. As we know, the collapse of the housing market then caused indebted households to default at unprecedented rates, setting off a massive global financial crisis.
Drennan focused on the average propensity to consume (APC), an economic statistic that measures the ratio of total consumption to total income. When the APC rises, workers are either saving less or going into debt. Many mid-twentieth century economists had predicted that the APC would remain constant. Instead it rose quickly, as income gains accrued mostly to the wealthy, and middle- and low-income earners spent more of their take-home pay to keep up. For Drennan, this was because stagnant or falling wages forced most Americans to reduce savings rates or take on the unsustainable debt that was the root cause of the financial crisis.