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Gennaro Zezza (2011) Income distribution and borrowing. Tracking the U.S. economy with a “New Cambridge” model”, in Giuseppe Fontana, Emiliano Brancaccio (eds.), The Global Economic Crisis: New Perspectives on the Critique of Economic Theory and Policy, Routledge, London, pp. 99-120
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Abstract: The purpose of this paper is to track down the origin of the global recession, which started in 2007, to the behaviour of the private sector in the U.S. economy. The mainstream interpretation of the crisis is that it originated from a low-probability shock to financial markets, and more specifically to the shadow banking sector which was not properly regulated. A new set of rules, combined with temporary measures to sustain aggregate demand, should therefore be sufficient – in the mainstream approach – to bring the economy back on its growth path. We claim instead that the crisis has its roots in the shift in income distribution towards the top quintile – a trend which is stronger in the U.S., but common to several developed economies since the 1980s – combined with an increasing role of relative consumption in households’ decisions. Financial markets allowed the private sector to finance expenditure beyond real disposable income, and provided a powerful channel for the globalization of the crisis. In our view, therefore, financial markets multiplied the crisis on a global scale, and more regulation will indeed be needed, but a sustainable growth path will not be achieved unless action is taken to revert to an income distribution which allows for sustainable growth in the living standards of the median household. Our view is grounded in the stock-flow-consistent approach of Godley, which is at the heart of the macroeconomic model being used at the Levy Institute of Economics, and proven to be a useful tool for anticipating and tracking the current recession in the U.S.. We use the model to compare our results with the original “New Cambridge” approach, and the current debate on “twin deficits” and the impact of fiscal policy.