Did inequality cause the crisis? – via Mostly Economics

There are two school of thoughts on what caused the US subprime crisis. http://mostlyeconomics.wordpress.com/ discusses the reasons here.  reposting the blog here:

  1. Raghuram Rajan’s famous book Faultlines there has been a lot of talk about inequality and how it cause the crisis. Rajan says inequality was rising in US and in order to avoid protests, politicians let people eat cheap credit. As people got cheap money, there were there were no real protests on rising inequality and people moved on. However rising credit led to other weaknesses in the financial system and as it happens in most crisis, a credit euphoria led to a bubble and then a crisis. So that is broadly Rajan’s discourse on why the crisis happened.
  2. This has been countered by Daron Acemoglu saying politicians have stopped responding to needs of lower class a long ago. They have just been looking at the top income class. The latter has captured the former  as a result we see higher incomes at the top and rising inequality. The seeds of the crisis were sown by this risk seeking top income class which took up higher leverage and made more and more money. When the risk turned other way, we had a huge crisis on hand.

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