Household Debt Accumulation and the Great Recession of the United States: A Comparative Perspective

Abstract

The Great Recession has provided an important intellectual challenge to both post-Keynesian and mainstream economists. In this article we survey some post-Keynesian views on household debt accumulation and the Great Recession of the United States, as well as the Atif Mian and Amir Sufi’s studies, perhaps the most influential and empirically-oriented studies of mainstream economics. We identify and distinguish their policy perspectives, and highlight commonalities and differences between them. By examining both post-Keynesian and Mian and Sufi’s views together, this paper emphasizes that, although there are clear differences between them, a careful examination reveals valuable complementarity which yields a better understanding of household debt accumulation and the Great Recession of the United States.

JEL classification: E21, E32, E52, E62

Keywords

household debt Great Recession relative income hypothesis inequality securitization subprime mortgage

1. Introduction

The US economy experienced a very significant rise in household debt leading up to the Great Recession. Household debt as a share of GDP, for example, increased from about 45 percent in 1975 to nearly 100 percent in 2006. This rise of household debt has been cited as the main source of the crisis of the Great Recession that started in 2007. Naturally, this major economic event has presented a significant intellectual challenge to both post-Keynesian and mainstream economists.¹ This challenge was particularly unexpected by mainstream economists as many believed that the problem of economic fluctuations had been largely solved. For example, Robert Lucas stated in his 2003 American Economic Association presidential address, “macroeconomics in this original sense has succeeded: its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades” (Lucas 2003: 1). Mainstream standard dynamic stochastic general equilibrium (DSGE) models of business cycles have largely ignored financial sectors, particularly financial factors at the household level, even after the 2007 Financial Crisis (Mian and Sufi 2010b: 78).²

By contrast, Atif Mian and Amir Sufi have produced a series of papers since 2009, which are considered to be seminar empirical studies on the issue of the rise of household debt in the United States and the Great Recession (Gertler and Gilchrist 2018: 6). In this paper, we compare and contrast some of the influential post-Keynesian research on the rise of household debt and the Great Recession to that of Mian and Sufi.

We do not imply that Mian and Sufi’s studies and their views are the only ones from the mainstream perspective. There are competing views to understand the Great Recession. For example, the financial accelerator approach, pioneered by Bernanke and Gertler (1989), has been extended from its initial emphasis on nonfinancial firms’ balance sheet constraints to households’ or banks’ balance sheet constraints (Justiniano, Primiceri, and Tambalotti 2010; Guerrieri and Lorenzoni 2017; He and Krishnamurthy 2013; Brunnermeier and Sannikov 2014). This perspective provides a competing argument against the views of Mian and Sufi, as it emphasizes the disruption of the financial system for credit intermediation as a main source of the crisis, and argues that the Great Recession would be far milder without the distress the financial system experienced (Gertler and Gilchrist 2018: 26). Their works focus largely on the extension of DSGE models to incorporate money and banking systems, and hence are the subject of the criticism by Rogers (2018a, 2018a).

We focus on Mian and Sufi’s work as it is empirical without reliance on the DSGE models. They adopt a pioneering approach to utilize detailed micro data to answer macro questions, which is relatively underexplored in post-Keynesian works. Their main focus of investigation is household indebtedness, which we believe was at the heart of the crisis.

Within the post-Keynesian tradition, we cover the ideas of Hyman Minsky and later works by some Minskyians, who extended Minsky’s early ideas. We also cover post-Keynesian consumption behavior, highlighting James Duesenberry’s relative income hypothesis (Duesenberry 1949) and the income distribution dimension to understand the rise of household debt in the United States. We examine their views on what caused the household debt accumulation prior to the Great Recession and what should have been the appropriate policy response to the Great Recession. Our survey of post-Keynesian views is partial due to space constraints, but also, more substantially, we emphasize these views as they provide institutional and historical pictures and they are, we believe, the most influential views within post-Keynesian research. However, it is important to note that these views are not without contentions, and we point out some disagreements at the end of section 2, where we discuss post-Keynesian views.

This paper shows that, although there are fundamental differences between the views of Mian and Sufi and post-Keynesians that stem from distinctions in theoretical backgrounds, their views also overlap. In fact, some of Mian and Sufi’s empirical results provide affirmative evidence for post-Keynesian ideas. By weaving together post-Keynesian analyses with the empirical studies of Mian and Sufi, our paper also highlights the relevance and importance of a post-Keynesian understanding of the central economic problems of the Great Recession.

Our paper is organized as follows. Section 2 presents post-Keynesian views. Minsky’s ideas and some important Minskyian extensions are discussed. Post-Keynesian views on income inequality, the relative income hypothesis, and consumption behavior are also discussed at the end. Section 3 surveys Mian and Sufi’s studies on the rise of household debt before the Great Recession. Section 4 discusses what would have been the right policy response to address the Great Recession according to both views. Commonalities and differences in their views are highlighted in section 5, while section 6 provides concluding comments.

2. Post-Keynesian Views

Post-Keynesians have long emphasized the integration of the real and financial sectors, and a possibility of instability arising from the financial sector (Minsky 1982, 1986). By utilizing and extending their existing frameworks, they have put forth insightful analyses of the rise of household debt and the Great Recession in the United States. In this section, Minsky’s ideas provide a starting point for our discussion. Some of the important Minskyian extensions are followed, and post-Keynesian analyses emphasizing income inequality, consumption, and the relative income hypothesis are discussed.

2.1. Hyman Minsky’s view

The processes which make for financial instability are an inescapable part of any decentralized capitalist economy. (Minsky 1982: vii)

Hyman Minsky and his financial instability hypothesis (FIH) are concerned with corporate debt. Therefore it would be misleading to think that Minsky’s FIH by itself provides a good description of household debt accumulation and the Great Recession. See, for example, Variato (2015) for the debate on whether the Great Recession should be characterized as a Minsky moment. However, Minsky’s idea has provided one of the most important conceptual frameworks to extend and apply for understanding the rise of household indebtedness and its implications for the Great Recession. Variato (2015: 31–32) summarizes the point well: “if the question one wants to investigate is whether or not the subprime crisis was as Minsky described in his own work, through specific examples, the answer is no. But if the alternative question is: can the FIH be used to understand and/or predict processes of endogenous financial instability, and is the subprime crisis, even not explicitly referenced, an event coherent with this framework, the answer is yes.”

Therefore, Minsky’s original works are still highly relevant and the most important starting point for this literature, extending in various directions. As the quote at the beginning of the section shows, Minsky saw capitalism as an inherently unstable system. Minsky highlighted the cash flow characterization of hedge-, speculative-, and ponzi-financing units. Economic entities such as firms, as Minsky initially emphasized, would go through these financing stages. As an economy experiences a prolonged period of stability, economic entities take more risky financial positions as stable economic conditions have rewarded their risk-taking behavior handsomely, and hence they become more financially fragile. In other words, they take the positions of speculative- and ponzi-financing units from the most healthy financial position of hedge units.³ The economy has, thus, become financially fragile and more susceptible to a financial crisis. “Stability breeds instability,” and this is an inherent characteristic of the capitalist economy.

For Minsky, government intervention, such as fiscal expansion and liquidity injection by monetary authorities, is necessary to prevent the economy from falling into a deep recession. Through fiscal expansion and deficit spending, governments can provide a direct source of profit to firms.⁴ Perhaps more importantly, central banks need to act as the “lender of last resort” to the banking/financial sector, by providing enough liquidity to permit firms to roll over their existing debt and still acquire necessary financing for their operation. In this regard, Minsky can be seen as representing the bank-lending view, which is discussed more in section 5.2:

The central bank’s function is to act as a lender of last resort and therefore to limit the losses due to the financial crisis which follows from the instability induced by the innovations during the boom. A combination of rapid central bank action to stabilize financial markets and rapid fiscal policy action to increase community liquidity will minimize the repercussions of the crisis upon consumption and investment expenditures. Thus a deep depression can be avoided. The function of central banks therefore is not to stabilize the economy so much as to act as a lender of last resort. (Minsky 1982: 176)

Minsky (2008) is a republication of the notes he informally prepared in 1987. In this paper, Minsky extended his analysis of financial evolution to consider securitization, and was prophetically ahead of his time. In this article, Minsky argued that securitization was a natural result of globalization and the monetarism of 1979 that sought to contain inflation by contracting money growth. Minsky (1996b) is the last article that shows his evolving view about the nature of capitalism. Minsky argued that the US economy had evolved into the stage of money manager capitalism.⁵ However, the detailed elaboration and description of this stage was left to other Minskyian scholars, as discussed below.⁶

2.2. Minskyian extensions

Randall Wray, in a series of papers, extended the idea of money manager capitalism. This is a line of thought by Minsky that built upon the analysis of finance capitalism developed by Rudolf Hilferding, Thorstein Veblen, John Maynard Keynes, and John Kenneth Galbraith (Wray 2011b: 1). According to Wray’s analysis, the US economy emerged out of the Great Depression and World War II with solid financial regulatory frameworks, lower private debt, big government spending, and sufficient wage income for workers to sustain a sufficient level of consumption. However, since the early 1970s, the US economy experienced a significant shift of economic regime. Unions and workers started to lose their collective bargaining power, resulting in stagnant real wage income; income and wealth inequality began to rise; government public spending started to slow down; trickle-down economics was promoted, emphasizing saving by richer, rentier households. Wray (2009) explains this change by adopting Galbraith’s (2008) concept of the predator state. According to this concept, a big government that is led by neoconservatives acts in the interest of money managers, and, under the slogan of free market economy, has transformed the US economy into the stage of money manger capitalism. The US economy experienced a shift of power toward the financial sector and management through regulatory and policy changes. Following Tymoigne (2010: 103–04), some of the regulatory changes Wray (2009: 815) highlights are: the Financial Modernisation Act of 1999 eliminating New Deal functional segregation; the Commodities Futures Modernization Act of 2000 which excluded new financial instruments from regulation; and an amendment to the Employee Retirement Income Security Act of 2000 which allowed pension funds to purchase investment-grade structured securities.

As Minsky (2008) points out, more recent forms of securitization also originated in the housing market, particularly in response to the interest rate hikes in 1979 under Paul Volcker monetarism. Banks’ funding ability was impaired due to the high interest rate environment, and hence they had to find a way to shift their assets off their balance sheets. Also, as the memory of the Great Depression and World War II disappeared, and technological and communication innovations allowed increased access to credit, US consumers relaxed their attitude toward borrowing-based consumption. Despite sluggish growth in government spending and wage income, the rise in debt-driven household consumption ushered in the so-called “Great Moderation,” paving the way for the critical stage of money manager capitalism. In other words, “stability breeds instability.” From this perspective, the true source of the problem for the Great Recession was not the unsustainable level of household debt accumulation or securitization, but the nature of capitalism (this time characterized by money manager capitalism) tending always toward a financially unstable state.

In sum, according to Wray’s analysis, US capitalism evolved into money manager capitalism. In this environment, we saw the rise in financial practices such as securitization. With fiscal restraint, a current account deficit, and rising income inequality, debt-financed private spending became prevalent. The crisis of 2007 was thus the result of a specific phase of capitalism, money manger capitalism, not an accidental debt crisis. The unsustainable increase in household debt and the Great Recession were results of a long-term transformation that Wray (2011a: 6) calls the “Minsky half-century.”

This long-wave view has become prominent for post-Keynesians more recently. Palley (2011), for example, formulates Minsky’s idea more explicitly from the long-wave perspective to understand the rise of household debt and the Great Recession. He distinguishes between short cycles and super cycles in interpreting the financial instability hypothesis. Palley relates Minsky’s financing taxonomy (hedge, speculative, and ponzi) with short cycles that an economy goes through more frequently in every business cycle, which he calls the Minsky basic cycle. A financial crisis, on the other hand, is part of a super cycle that is associated with more fundamental structural changes through several business cycles. These fundamental structural changes involve various forms of regulatory relaxation in the financial sector and increasingly more risk-taking behavior. Particular aspects of each crisis are history-specific—as in the Great Recession and an unsustainable accumulation of debt prior to that—but the true source of the problem is again capitalism itself, with its “success breeds excess breeds failure” (Palley 2011: 32) characteristic.

Dymski (2010) provides another analysis, extending and modifying Minsky’s ideas for the present context. Dymski highlights securitization and the spread of loans to minority and lower-income households as the main cause of household debt accumulation and the Great Recession. According to his analysis, the US banking system experienced dramatic changes that started in the 1980s after the savings and loan crisis and deregulation: “Loan crises and deregulation in the 1980s brought about change: an end to geographic and product-line restrictions; bank failures and bank mergers across state lines; the decimation of the thrift industry. . . The US system of mortgage finance was radically reshaped: lenders made loans to sell them, thereby also offloading financial risk” (Dymski 2010: 245). Mortgage loans, which used to be held by lending banks prior to the 1980s, became mortgage-backed securities and were sold off into the secondary market. Furthermore, “the onset of securitization opened the door to the targeting of socially-excluded or vulnerable populations for financial exploitation. Those previously denied mortgage credit were now provided with high-cost, high-risk loans” (Dymski 2010: 253). Beginning in the 1990s, with the spread of securitization, financial systems expanded the loans, often predatory and subprime, to minority and lower-income households that had previously been overlooked.

Dymski argues that banks are not the most leveraged units due to the originate-and-distribute model of finance via securitization: “These banks are not lenders in any traditional sense. They make loans that are sold off onto the markets: they originate financial risks but do not bear them” (Dymski 2010: 252).⁷ The most leveraged units are the subprime households with “nothing-down subprime loans,” since they start with zero equity (Dymski 2010: 252).⁸

Contrary to Minsky’s envisioned role of the central bank as the lender of last resort, liquidity injections to the banking/financial sector were therefore not sufficiently effective to address the Great Recession: “Minsky’s ideas about stabilisation assume that in any crisis the Federal Reserve would have leverage over a banking system that represented the fulcrum of the economy’s financing process. This has not been the case. Banks’ outsourcing of much of their lending/borrowing has rendered an extensive roster of central-bank interventions ineffectual. Indeed, both ‘big bank’ methods and ‘big government’ policies have only limited damage and not triggered recovery” (Dymski 2010: 253).

2.3. Inequality, consumption, and relative income hypothesis

Minskyian analyses as discussed above, although they recognize the importance of the rise of debt-financed consumption for debt accumulation, do not explore it in detail. This dimension is emphasized and developed by researchers who have incorporated the idea of the relative income hypothesis by Duesenberry (1949) into post-Keynesian frameworks. According to the relative income hypothesis, consumption behavior is socially interdependent. Therefore one’s consumption pattern may be affected by his/her consumption reference group. This is often referred to as the consumption emulation effect, as well as the keeping up with the Joneses effect. Also, according to the relative income hypothesis, consumption behavior is path dependent. In other words, past consumption levels and patterns influence current consumption behavior—also referred to as the habit formation or habit persistence theory (Marglin 1984). Frank, Levine, and Dijk (2014) extend the relative income hypothesis into the concept of expenditure cascades. According to this concept, as there are vertical layers of reference groups, one’s consumption should be partly affected by a group which has a considerably higher level of income through the chain of reference groups.

Cynamon and Fazzari (2008) apply and extend Duesenberry’s relative income hypothesis in explaining contemporary household behavior. Consumer preferences endogenously evolve in a social context and hence households learn consumption patterns from social reference groups. In the current context, the social reference group is not limited to family members, friends, and neighbors on the same street. It has expanded through, for example, advertising and mass communication tools, whereby the consumption patterns of the richer population are more commonly exposed. The authors suggest that consumption and borrowing norms had shifted upward and become an important factor in the rise in consumer and household debt in the United States. They point out that, although this has provided a substantial macroeconomic stimulus since the 1980s, it has also increased household financial fragility.

Cynamon and Fazzari (2016) provide a more in-depth elaboration on income inequality, consumption, and borrowing in the United States. They provide a convincing argument through evidence showing that income inequality for the bottom 95 percent had widened since the mid-1980s through 2007. At the same time, it had sustained a consumption rate relative to disposable income. This implies a possibility that its indebtedness (debt-to-income ratio) and net worth had been on an unsustainable path. This is in contrast to the top 5 percent for whom income growth accelerated, debt/income ratios were stable, and net worth rose relative to income prior to the Great Recession (Cynamon and Fazzari 2016: 386).

Figure 1 shows the well-documented rising income inequality in the United States since the early 1980s. Under an environment of rising income inequality, workers, other things being equal, will have to adjust their consumption behavior. However, figure 2 shows that the consumption rate of the bottom 95 percent was quite stable despite rising income inequality until the Great Recession hit. On the other hand, the top 5 percent’s consumption rate was volatile, showing evidence that this group smoothed their consumption relative to income. At the same time, as figure 3 shows, household debt relative to income for the bottom 95 percent increased very significantly from 75 percent to more than 175 percent, while the same measure for the top 5 percent was quite stable.

Figure 1.

Top 5 percent income share.

Figure 2.

Disaggregated personal consumption and outlay rates.

Figure 3.

Household debt to disposable income.

When the recession hit in 2007, the consumption of the bottom 95 percent, unlike prior recessions, declined significantly, as figure 2 shows. Cynamon and Fazzari argue that the observed consumption dynamics are the main reason why the United States experienced a deeper recession. In other words, the data are consistent with the interpretation that “households in the bottom 95 percent were consuming and borrowing at unsustainable rates. When new borrowing dried up as the Great Recession began, the bottom 95 percent consumption rate was forced downwards” (Cynamon and Fazzari 2016: 387). According to their analysis, inequality was central to the macroeconomic dynamics of household debt accumulation and consumption before and during the Great Recession (Cynamon and Fazzari 2016: 388):

Again, we argue that the relationship between inequality and economic crisis was not a coincidence. The evidence implies that the bottom 95 percent responded to slower income growth and higher interest rates, beginning in the early 1980s, by taking on more debt rather than by reducing consumption enough to keep its debt/income ratio stable. This outcome, in a sense, temporarily rescued the US economy from the demand drag that many theories predict as a result of rising inequality. But the deteriorating balance sheets of the bottom 95 percent eventually set the stage for the Great Recession. . . The rise of inequality is easily large enough that it could potentially account for the entire increase in bottom 95 percent debt leverage, an increase that spawned the Great Recession. (Cynamon and Fazzari 2016: 389)

The preceding analysis raises the question of why the bottom 95 percent let their balance sheets deteriorate through borrowing in the environment of rising income inequality. Cynamon and Fazzari (2016) provide an explanation based on the idea of habit persistence, expenditure cascades, and the relative income hypothesis. Though the bottom 95 percent income growth slowed, due to habit persistence, this did not induce any significant change in consumption norms. Meanwhile, rising income inequality put upward pressure on their consumption patterns through the channels of consumption emulation and expenditure cascades, while innovations such as credit-reporting systems and securitization created an unprecedented level of credit availability. This allowed a large population, through borrowing, to maintain consumption behavior dictated by consumption emulation, expenditure cascades, and habit formations:

For an extended period, middle-income households who were falling behind high-income households were able to drive their leverage up without deviating from established norms of behaviors, in both spending and financing, that they observed in their reference groups. As the empirical results in section 4 demonstrate, however, these trends were on a collision course with reality. When the Great recession hit, the bottom 95 percent could no longer maintain consumption norms by borrowing. Credit availability collapsed quickly, forcing de-leveraging and reduced spending. (Cynamon and Fazzari 2016: 392)

Cynamon and Fazzari (2015) make essentially the same point based on their analysis in Cynamon and Fazzari (2016): “From the early 1980s until the eve of the Great Recession, the bottom 95 percent maintained high consumption despite their stagnating income, postponing demand drag from rising inequality. The result was an ultimately unsustainable, but persistent, increase in household leverage and financial fragility” (Cynamon and Fazzari 2015: 177). From their perspective, the inequality also explains the slow recovery of consumption spending and output in the United States since the Great Recession, as they point out that “the effect of inequality on demand generation was postponed by massive consumer borrowing for an extended period prior to the Great Recession, but it now is holding back output and employment” (Cynamon and Fazzari 2015: 180).

The emphasis on the linkage between income inequality, debt-financed consumption, and household debt accumulation has been perhaps the most influential argument in the post-Keynesian literature.⁹ However, it is important to note that this view is not without disagreement. Wildauer (2016), based on the Survey of Consumer Finance, points out that, from 1989 to 2007, the share of total household debt used for home purchases and home improvements increased from 74 percent to more than 82 percent, while the share used for consumption declined from about 16 percent to 9 percent. In other words, according to this study, consumption-induced borrowing does not explain a large part of the increase in household debt.¹⁰ Stockhammer and Wildauer (2016), in their study of a panel of eighteen OECD countries including the United States, covering the period 1980–2013, attempt to capture expenditure cascades effect, as they add inequality measures such as the Gini coefficient and the share of the richest 1 percent of households as a regressor in the consumption function, and find no significance. In short, according to these studies, it is still an important and unresolved question as to what was the fundamental cause of the expansion of household indebtedness prior to the Great Recession.

3. Atif Mian and Amir Sufi’s View

Mian and Sufi, in a series of papers, have provided perhaps the most definitive and insightful studies, from mainstream perspectives, on the rise of household debt and the Great Recession in the United States. Mian and Sufi (2009) empirically examine competing explanations for subprime mortgage expansion using micro data, focusing on the period between 2002 and 2005. Those competing explanations are: the income-based hypothesis, which suggests that the income prospects of subprime borrowers might have improved in the early 2000s; the supply-based hypothesis, which argues that there was a significant increase in the mortgage supply by lenders due to, for example, securitization; and the expectation-based hypothesis, which suggests that there was increased lending due to the expectation of increasing house prices. They gather and utilize zip code-level data for 3,014 zip codes in 166 counties covering over 45 percent of aggregate home debt. They identify borrowers with a credit score below 660, as of 1996, as subprime borrowers, and divide their sample between subprime zip codes and prime zip codes based on the fraction of subprime borrowers. Subprime zip codes are in the highest quartile, while prime zip codes are in the lowest quartile. On average, the fraction of subprime borrowers in the subprime zip codes is 0.444, and in the prime zip codes is 0.159 (Mian and Sufi 2009: 1456–57).

Their key finding is that the supply-based hypothesis is most consistent with the data, and figure 4 succinctly summarizes the result. The top left-hand panel plots the percentage of application denied in each zip code against the fraction of the population that were subprime borrowers in 1996. This plot shows that higher subprime population shares are associated with higher denial rates for credit. This indicates that there was initially credit rationing for subprime borrowers (Mian and Sufi 2009: 1477). On the other hand, the top right-hand panel of figure 4 plots the difference in denial rate for mortgage application between subprime and prime zip codes from 1996 to 2007. This plot shows that the loan denial rate for subprime zip codes falls disproportionately from 2002 to 2005 compared with prime zip codes (Mian and Sufi 2009: 1479). In other words, there was significant credit expansion in subprime areas between 2002 and 2005.

Figure 4.

Relaxation in borrower credit constraints.

The bottom left-hand panel of figure 4 plots the fraction of new mortgages sold to non-government sponsored enterprise (GSE) investors, and the bottom right-hand panel of the figure plots the relative growth in mortgages, between subprime and prime ZIP codes, that were sold to non-GSE investors. The bottom left-hand panel indicates that there was a sharp increase in mortgages sold by originators to non-GSE investors between 2002 and 2005 (30 percent between 1996 and 2002 compared with 60 percent between 2002 and 2005). The bottom right-hand panel on the other hand shows zip codes around the same period (Mian and Sufi 2009: 1479). Furthermore, they document the evidence that these mortgages sold to non-GSE institutions from subprime areas were largely for securitization: subprime population share is positively correlated only with the change in mortgages sold by originators for securitization (Mian and Sufi 2009: 1482): “The fraction of home purchase mortgages that were securitized by non-government sponsored enterprise (GSE) institutions rose from 3 percent to almost 20 percent from 2002 to 2005, before collapsing completely by 2008. . . non-GSE securitization primarily targeted zip codes that had a large share of subprime borrowers” (Mian and Sufi 2010a: 52). In sum, Mian and Sufi provide evidence of securitization as a reason for credit expansion in subprime areas. Furthermore, they also document that the change in mortgages sold for securitization is positively correlated with a subsequent increase in default rates in subprime ZIP codes (Mian and Sufi 2009: 1482). Securitization prevented lenders and borrowers from efficient renegotiation, and hence stressed borrowers were more likely to experience foreclosures if their mortgage was held in a securitization pool rather than on the balance sheet of an individual bank (Mian and Sufi 2015b: 139).

The sharp rise in securitization coincides with the inversion in the correlation between credit and income growth in 2002, from positive to negative. The period from 2002 to 2005 was the only period of negative correlation since 1991. Subprime zip codes with very high relative mortgage growth were particularly prone to experience lower income growth, and they also experienced significantly greater house price growth at the same time (Mian and Sufi 2009: 1487). In other words, there was a disconnect between income dynamics and house prices between 2002 and 2005, particularly within the subprime zip code areas. This timing again coincides with the period of expansion of subprime mortgage securitization. Based on these findings, Mian and Sufi (2009: 1490) suggest that “the expansion of mortgage originations in subprime ZIP codes, driven by securitization, may itself be responsible for the relative house price growth in subprime areas.”

Mian and Sufi (2011) investigate an additional dimension of household borrowing by estimating the effect of rising house prices on home equity-based borrowing between 2002 and 2007. They examine a random sample of 74,149 homeowners, who owned their homes as of 1997, in 2,307 zip codes from the end of 1997 until the end of 2008 (Mian and Sufi 2011: 2132). Their conservative calculation suggests that total borrowing due to house price appreciation represents 53 percent of the overall increase in debt of homeowners from 2002 to 2006, which is 1.25 trillion dollars (Mian and Sufi 2011: 2154). They also estimate that defaults due to home equity-based borrowing by homeowners represent at least 39 percent of total new defaults in the economy during this sample period of 2002–06 (Mian and Sufi 2011: 2135). According to their study, low-quality borrowers with low credit scores and high credit card usages (subprime borrowers) were the ones who borrowed aggressively against their rising home equity, and experienced higher default rates starting around 2006 (Mian and Sufi 2011: 2143). They also explore how this equity-based borrowing is used. Their findings seem to suggest that “a large fraction of home equity-based borrowing is used for consumption or home improvement” (Mian and Sufi 2011: 2152). These results show that a large part of the default crisis was due to households, especially subprime households, borrowing for consumption-related expenditures against home price appreciation, which was driven by securitization and the expansion of credit supply as reported by Mian and Sufi (2009).

The next natural question is: why was there a significant expansion of subprime mortgages right before the crisis? Mian, Sufi, and Trebbi (2013) explore a political dimension to answer the question. They find that campaign contributions from the mortgage industry and subprime borrowers in their congressional districts seemed to influence the voting behavior of representatives and hence shaped policy that helped to promote the expansion of subprime mortgages. According to their study, there was a sharp increase in mortgage industry campaign contributions and campaign lobby expenditures between 2002 and 2006: mortgage industry campaign contributions increased 80 percent compared with the 40 percent increase of non-mortgage financial firms, and lobbying expenditure by the mortgage industry increased significantly faster than the non-mortgage financial industry, from 25 million dollars in 2001 to almost 50 million dollars in 2004 (Mian, Sufi, and Trebbi 2013: 388).

More specifically, beginning in the 107th Congress (2001–02) until 2007, there were significant campaign contributions from the mortgage industry to representatives from the districts with a high subprime borrower share (Mian, Sufi, and Trebbi 2013: 406): “a one standard deviation increase in the fraction of subprime borrowers in a given district leads to an 80 percentage point increase in the growth of mortgage campaign contributions from 2002–2006” (Mian, Sufi, and Trebbi 2013: 376). The authors also document that, between 2000 and 2004, the fraction of subprime borrowers in congressional districts and the level of campaign contributions from the mortgage industry seemed to be correlated with the voting pattern of representatives on housing and housing finance-related legislation. This timeline also coincides with a dramatic increase in mortgage lending and securitization to high subprime areas between 2001 and 2006, as Mian and Sufi (2009: 388) documented. In sum, their results suggest that “constituent interests, measured with the fraction of subprime borrowers in a given congressional district before the subprime mortgage expansion, and special interests, measured with campaign contributions from the mortgage industry, both helped to shape government policies that encouraged the rapid growth of subprime mortgage credit” (Mian, Sufi, and Trebbi 2013: 375).¹¹

Mian and Sufi identify government as a main source of “shocks” that encouraged the debt expansion: “debt is cheap because the government massively subsidizes its use” (Mian and Sufi 2015b: 182); “the government provides large tax subsides to debt financing, and this encourages a financial system overly reliant on debt contracts” (Mian and Sufi 2015b: 180). This view has a similarity with Rajan’s (2010) argument that debt expansion to lower-income households is due to government policies to expand credit to them in response to growing income inequality in the United States since the early 1980s. However, it should be noted that, unlike Rajan (2010), Mian and Sufi’s studies do not highlight the income inequality dimension as a main factor for inducing credit expansion.

In sum, Mian and Sufi identify three related factors in the rise of household debt between 2001 and 2007. First, there was a significant expansion of the supply of credit due to securitization, especially to subprime borrowers, pulling them into the housing market. This, in turn, pushed up house prices especially in the areas populated with large numbers of subprime borrowers. Second, existing homeowners made use of the opportunity of increasing house prices and low interest rates to extract home equity for consumption expenditures and home improvement. Third, starting in 2000, campaign contributions to representatives in high subprime borrower share areas from the mortgage industry expanded, and this seemed to influence congressional voting behaviors in favor of the mortgage industry.

4. Policy Responses

The main reason for such a significant decline of real economic activity during the Great Recession was, according to Mian and Sufi, the expenditure reduction by distressed households with high indebtedness and foreclosures as well as the lack of credit availability. Mian and Sufi (2010b) find that the growth in household leverage from 2002 to 2006 and household dependence on credit card borrowing as of 2006 are quantitatively sufficient to explain the entire rise in household defaults, the drop in house prices, and the fall in auto sales (Mian and Sufi 2010b: 78). High-leverage counties experienced considerably more severe house default rates beginning in the second quarter of 2006 and a very significant drop in house prices starting in 2006 compared with low-leverage counties.¹² At the same time, high-leverage counties experienced a considerably more severe reduction in economic activity (measured by the growth of auto sales and new housing permits) and unemployment, compared with low-leverage counties, although both groups saw serious reductions in economic activity according to those measures during the last part of the recession.

Mian and Sufi (2015a) investigate the effect of house foreclosures on house prices and economic activities.¹³ Their results indicate that foreclosures led to a marked drop in house prices, deteriorating the balance sheet of households and their net worth, and hence had a significantly negative impact on real economic activity such as residential investment and consumer demand. Specifically, according to their calculation, from 2007 to 2009, “foreclosures were responsible for 33 percent of the decline in house prices, 20 percent of the decline in residential investment, and 20 percent of the decline in auto sales” (Mian and Sufi 2015a: 2590).

Based on these studies, Mian and Sufi advocate for what we call the aggregate demand view, which is the perspective that the main driver of the Great Recession was a reduction of consumption by distressed households who experienced a significant reduction of housing prices and saw their mortgages go underwater. The people that experienced this stress were generally lower-income households who had a higher marginal propensity to consume (MPC) out of their wealth, which is dominated by their housing wealth, compared with the lenders who are richer and have a lower MPC out of their wealth. Mian and Sufi (2013: 1717) find that “the MPC for households in ZIP codes with an average adjusted gross income (AGI) less than 35,000 dollars is almost three times as large as that for households in ZIP codes with an average AGI greater than 200,000 dollars”; “ZIP codes that entered the Great Recession with a housing loan-to-value (LTV) ratio of 90 percent had an MPC out of housing wealth that was three times as large as the MPC of households in ZIP codes with only a 30 percent housing LTV ratio” (Mian and Sufi 2013: 1689). Those who are underwater on their mortgages naturally reduce their consumption. Through the multiplier effect, this causes a reduction in employment and a deeper recession. From the aggregate demand view, the solution to the Great Recession is to reduce the debt burden of distressed households through the write-down and restructuring of their mortgage debt to prevent foreclosure and reduction of consumption.¹⁴ In other words, restructuring debt in favor of borrowers would have promoted more equal sharing of losses and “transferred wealth from people with very low marginal propensities to consume to people with very high marginal propensities to consume. This would have boosted overall demand. A creditor barely cuts spending when a dollar is taken away, but a borrower spends aggressively out of a dollar gained. . . indebted households had MPCs out of wealth that were three to five times larger than others” (Mian and Sufi 2015b: 141).

This aggregate demand view has some similarities with what we call the inequality view, a line of thinking presented by post-Keynesian researchers that emphasizes rising income inequality, especially in its association with consumption behavior described by the relative income hypothesis, as an important reason for debt accumulation prior to the Great Recession. Cynamon and Fazzari (2015: 180) point out that the slow recovery of the United States is due to a demand generation problem, largely because of the stagnation of the bottom 95 percent of consumption growth. From this perspective, the real solution to the problem must work toward reducing income inequality in the United States: “a first step towards resolving the problem is to have a clear understanding that rising inequality goes beyond the issue of social justice. . . greater inequality also compromises the demand engine that was necessary for acceptable macroeconomic results in the USA prior to the Great Recession, and greater inequality threatens demand growth and employment going forwards” (Cynamon and Fazzari 2016: 393). Based on this understanding, Cynamon, Fazzari, and Setterfield (2013: 9) argue that “public policy should strive to revive the income share of working and middle-class households, and to realign wage and productivity growth. This would allow for sustainable growth in household consumption expenditures. On the domestic front, rethinking the changes in labor law that weakened the bargaining power of workers over the past 30 years could help reach this goal.” Although there are some similarities, it is important to realize that the inequality view emphasizes, unlike the aggregate demand view advocated by Mian and Sufi, the long-term structural problem of rising inequality, rather than addressing the short-term demand-generation problem caused by the fall in house prices and rising foreclosures during the Great Recession.

On the other hand, post-Keynesians extending the thesis of money manger capitalism tend to emphasize, following the original idea of Minsky, the bank-lending view,¹⁵ which emphasizes the lending channel of the bank and financial sectors. For businesses to be able to sustain themselves, they need access to credit facilities from the financial sector. Therefore, to mitigate the effect of financial crisis, it is important to insure that the banking sector has healthy liquidity, thus allowing the sector to continue lending to other businesses. In this view, central banks must work as the “lender of last resort” to the banking/financial sector, providing enough liquidity to allow firms to roll over their existing debt and still acquire the necessary financing for their operations.

However, taking a longer-term view these post-Keynesian scholars also understand the importance of solving the fundamental problem of income inequality and demand generation: “we need policy that promotes rising wages for the bottom half so that borrowing is less necessary to achieve middle class living standards, and policy that promotes employment” (Wray 2009: 826). Minsky (1996b: 4) advocated full employment based on “special employment programs of the federal, state and local government.” This idea is extended into the advocacy of an employer of last resort program by Minskyian scholars (Wray 2011a). In this jobs program, “government would offer a perfectly elastic supply of jobs at a basic program wage. Anyone willing to work at that wage would be guaranteed a job” (Wray 2011a: 11); this program would provide “useful services and public infrastructure, improving living standards” (Wray 2011a: 11). It would be also a stabilizing force by providing a decent wage to finance consumption.

5. Highlighting Common Views and Differences

In this section, based on our survey of post-Keynesian ideas and Mian and Sufi’s analyses above, we highlight common views and differences between them. By comparing and contrasting them, we also speculate on the possibility of a synthetic understanding.

5.1. Common views

Securitization is perceived to be an important driver for household debt accumulation for both post-Keynesians and Mian and Sufi. Wray (2008) emphasizes the importance of securitization, following Minsky (2008), in the expansion of lending to the borrowers, such as those on lower incomes and minorities, who previously did not have access to such credit. Dymski (2010) put forth a similar argument, especially in relation to minority and lower-income households. While their arguments are convincing and insightful, there are no systematic empirical studies to investigate this channel of securitization for credit expansion. In fact, the series of studies by Mian and Sufi mentioned in this paper provides concrete evidence for the prominent role of securitization in expanding credit to subprime borrowers.¹⁶ Both Mian and Sufi and post-Keynesians such as Dymski also realize that securitization makes it difficult for renegotiation of a mortgage, and hence stressed borrowers were more likely to experience foreclosures if their mortgages were held in a securitization pool (see Mian and Sufi 2015b: 139; Dymski 2010: 250).

Dymski (2010) as well as Mian and Sufi are skeptical of the bank-lending view. Dymski argues that households with subprime mortgages were the most leveraged economic units, not banks, as banks sold off the loans they made to security markets. Therefore central bank policy that provided liquidity to the financial system was not sufficient to contain the Great Recession. Mian and Sufi, on the other hand, perceive that some of the programs of the Federal Reserve and US Treasury were needed to prevent the financial system from bank runs and to protect the payment system. However, their view is that the main policy focus should have been on reducing the burden of indebted households. In their view, the lack of aggregate demand, due to distressed households, was at the center of the Great Recession. Mian and Sufi’s argument also shares a similarity with the post-Keynesians’ view (such as Cynamon and Fazzari 2016), which argues that the main cause of the recession and slow recovery was stagnant consumption from indebted working- and middle-class households. This similarity is explored more in section 5.3.

As mentioned in section 4, there is a similarity between the aggregate demand view by Mian and Sufi and the inequality view by post-Keynesians. Both emphasize that generation of effective demand through consumption is the key solution for the Great Recession. For this reason, as we mentioned, Mian and Sufi advocate the restructuring of mortgage debt in favor of borrowers to boost their consumption, and post-Keynesians argue for policies to reduce income inequality. However, there is also a fundamental difference regarding their views on the importance of demand, and this is explained further in section 5.2.

It is also noteworthy that Mian and Sufi’s aggregate demand view is, in terms of its emphasis on the effect of debt burden on consumption, somewhat similar to the post-Keynesian idea emphasizing the role of debt in a financial theory of the business cycle. Palley (1994), for example, emphasizes the different MPC out of disposable income between debtors and rentiers in a linear multiplier–accelerator model. He shows that the rising debt service burden reduces consumption and output levels as there is a transfer of income from high-MPC agents (debtors) to low-MPC agents (rentiers), and this provides a mechanism for a credit-driven cyclical process of output.

Mian and Sufi (2010a: 55) argue that political institutions influenced by the financial industry are unlikely to impose proper losses on the financial industry, and hence credit-driven cycles may be a recurring feature of the economy. This argument can be also related to what Pollin (1997) calls the Minsky paradox: government intervention and the lender of last resort function of the central bank will validate fragile financial positions of economic agents, so that risky financial practices are allowed to continue or even get worse: “Government policy is called on increasingly to bail out the financial system and thereby avoid a depression, but this very policy encourages more fragility and thus increases the burden placed on future policy interventions” (Pollin 1997: 85).

5.2. Differences

Although there are some common views, there are also clear distinctions stemming from the authors’ different views on capitalism and the theoretical frameworks that they adopt. First of all, there is a clear difference in terms of the time frame under consideration (see Figure 5). Mian and Sufi’s studies focus on the period of 2002–7. Mian, Sufi, and Verner (2017) is the only exception among Mian and Sufi’s studies, as it uses panel data from thirty countries from 1960 to 2000. However, it again focuses on the medium-run effect, not the long-run effect. It utilizes a vector autoregression of the log real GDP, the level of household debt to GDP, and non-financial firm debt to GDP without any consideration of long-run relationships such as cointegration. It also utilizes a single equation framework only, to capture, for a given time, the effect of rise in household debt over the previous three years to the subsequent GDP growth over three years. The authors are very clear, throughout the paper, that their focus is to capture the medium-run effect of the rise of household debt to output, not to detect any long-run trend.

Figure 5.

Household debt/disposable income ratio.

On the other hand, post-Keynesians look at a much longer time horizon and their investigations focus on the long-term trend. The money manager capitalism framework focuses on the whole postwar period, from the 1950s until the Great Recession—the “Minsky half-century.” Dymski’s focus starts with the 1980s. Cynamon and Fazzari also utilize data starting in the 1980s. This difference in the time period considered in the respective analyses is of importance to this discussion. Post-Keynesian economists provide historical and institutional analysis tracing back to these years as an origin of the crisis because of their views on the incomplete nature of capitalism. Mian and Sufi’s view of crisis, on the other hand, is from the mainstream perspective of business cycles which is driven by unforeseen economic events, often called “shocks.”

For post-Keynesians, financial crisis is an endogenous phenomenon, although some details of it should vary due to different historical circumstances and institutions. However, mainstream economists such as Mian and Sufi perceive that a financial crisis is caused by an exogenous shock: “the advent of subprime mortgage securitization represented a credit supply shock that provided new home purchase financing for a segment of the population that traditionally was unable to obtain mortgages” (Mian and Sufi 2010b: 79). Mian and Sufi therefore need to identify such shocks, and Mian and Sufi (2009) and Mian, Sufi, and Trebbi (2013) that we discussed in section 3 are in fact their attempts to do so. Mian, Sufi, and Verner (2017), which deals with the panel data set of thirty countries, also examines the data in the light of possible shocks suggested by the mainstream theoretical literature and provides a supportive argument for credit supply shocks that induced credit expansion. Mian and Sufi (2015b: chapter 7) also identifies a capital inflow for safe assets after the 1997 Asian Financial Crisis started in Thailand and the securitization of mortgages as credit supply shocks that allowed credit expansion in the United States prior to the Great Recession.

For post-Keynesians, identification of these kinds of shocks seems to be less important, as the true source of the endogenous financial crisis comes from the very nature of capitalism: “many accounts blame subprime mortgages (home loans made to riskier borrowers, typically low-income households) for the global financial collapse but that is obviously much too simple” (Wray 2011a: 7). This difference is also closely related to the endogenous money and credits view of post-Keynesians and the idea of exogenous credit supply constraints of Mian and Sufi and the mainstream in general.

From the post-Keynesian endogenous money view, money is created through lending by banks. In other words, the supply of money “is determined by the demand for bank credit (loans)” (Lavoie 2014a: 57). The expansion of credit, accumulation of debt, and consequential increase in financial fragility is therefore a natural part of system. The potential for financial crisis to occur is always there in the system, and hence it is an endogenous phenomenon, although what induces the unsustainable level of credit expansion and debt accumulation would depend on the different historical circumstances. On the other hand, for Mian and Sufi—as they seem to believe that the credit supply is constrained—unsustainable levels of credit expansion and debt accumulation, and hence financial crises, are abnormal events that are caused by unexpected exogenous factors.¹⁷

Income inequality has been an important reason for household borrowing and debt accumulation for post-Keynesians (see, in addition to the studies discussed above, among others Palley 2002; Brown 2008; Barba and Pivetti 2009; van Treeck 2014). Mian and Sufi (2009) document some evidence of increasing income inequality, as they find that, between 2002 and 2005, “high-subprime share ZIP codes experience relative declines in income, employment, and establishment growth compared with other ZIP codes in the same country. In other words, mortgage origination growth is stronger in high subprime ZIP codes despite relatively worsening income, employment, and business opportunities in these areas” (Mian and Sufi 2009: 1468). However, there is no attempt in Mian and Sufi’s papers published in academic journals to date to delve further into income inequality as a possible driver of household borrowing.

Mian and Sufi (2015b) briefly mention, in the afterword of their more general audience book, that the United States experienced a rise in inequality and debt (government and household) together since the 1980s: “the relationship between the rise in inequality and the rise in total debt in the United States is a close one” (Mian and Sufi 2015b: 194). From their perspective, this rising inequality provided a source of credit expansion as the wealthy were able to save more, and borrowing and hence debt consequently grew. In this sense, Mian and Sufi see that income inequality and the consequential increase in wealth inequality provided a source of credit supply expansion, although this point is made quite briefly. Note that this is again related to the view of supply side credit constraints emphasized by Mian and Sufi, which is different from the endogenous money view of post-Keynesians. From the endogenous money perspective, the supply of money is determined by the demand of credits, and, as mentioned in section 2, inequality has been emphasized by post-Keynesians as a driver of credit demand.

In mainstream accounts, the permanent income/life cycle theory of consumption is still a dominant way of thinking about consumption behavior. As discussed earlier in this paper, Mian and Sufi (2011) find very significant borrowing and debt accumulation through home equity in the environment of rising house prices and relative income decline in subprime areas compared with prime areas, and that those credits were mostly used for consumption expenditures and home improvement. However, they cannot properly explain this phenomenon through the neoclassical theory of consumption behavior. In fact, some of their empirical results are inconsistent with life cycle models: “the evidence suggests that the borrowing of older consumers is less responsive to house price growth than that of young consumers, which is inconsistent with life-cycle models of consumer financial behavior” (Mian and Sufi 2011: 2145). However, for post-Keynesians the relative income hypothesis is naturally compatible with their theoretical frameworks,¹⁸ and hence can provide a coherent theoretical explanation, via consumption behavior, for rising household borrowing and indebtedness in the environment of rising income inequality.¹⁹

There are also quite different views on fiscal spending. For post-Keynesians, in addition to the role of central banks as a lender of last resort, it is critical for government to sustain demand and business profits through deficit spending during the recession and crisis as it “puts a floor to falling income and profits” (Wray 2011a: 5). Furthermore, even during normal times, post-Keynesians in general view large government spending favorably as a source to generate and sustain demand, income, and profit.²⁰

Mian and Sufi understand the positive aspect of fiscal expansion during the crisis, as they state that “fiscal stimulus can help, and efforts to impose austerity in the midst of a levered-losses episodes are counterproductive” (Mian and Sufi 2015b: 163). However, their view on fiscal expansion is quite skeptical in general due to their acceptance of Ricardian equivalence (Barro 1975): “most economists agree that in normal times government spending has little effect on the economy, because it crowds out private spending and because households understand that they eventually have to pay higher taxes to finance the spending. If anything, government spending may hurt in normal times because it distorts incentives through taxation” (Mian and Sufi 2015b: 162); “further, government spending must eventually be paid for by someone through taxes. Unless those taxes fall on creditors in the economy who were responsible for the housing boom, fiscal policy fails to replicate the transfer from creditors to debtors that most effectively boosts aggregate demand” (Mian and Sufi 2015b: 164). Mian and Sufi (2012) is their only study to examine the effects of fiscal stimulus, and they do so in the context of the 2009 Cars Allowance Rebate System program.²¹ Their study finds that there was no cumulative effect of the program on car purchases within a year right after the program was implemented. Furthermore, this particular form of stimulus had no effect on employment, house prices, and household defaults rates.

This different view on the fiscal policy is also related to the more fundamental difference between Mian and Sufi (and mainstream economics in general) and post-Keynesians with respect to output determination. From the post-Keynesian framework, demand is the main determinant of output not only in the short run, but also in the long run. The Mian and Sufi view is that output is determined by the supply side in general, and that demand-driven output determination is a special case due to frictions such as nominal rigidities and monetary policy constraints. In other words, economic activity is demand-driven only under certain circumstances such as the zero-lower bound (Mian and Sufi 2015b: 54).

One of the main highlights of Mian and Sufi’s contributions is that they utilize micro data to correctly identify the channel and mechanism working at the macro level regarding the debt explosion and the Great Recession. In fact, by doing so they provide evidence consistent with some post-Keynesian ideas, as discussed in this paper. The use of micro data in post-Keynesian macro studies is mostly absent.²² The importance of heterogeneity in economic agents has long been recognized by post-Keynesians, and utilizing micro data to highlight the effect of heterogeneous labor and households would possibly be a promising research avenue.

5.3. Is synthetic understanding possible?

As we discussed above, there are clear differences between post-Keynesians and Mian and Sufi, but there also seems to be significant complementarity in their views allowing for the possibility of a synthesized understanding of the rise of household debt and the Great Recession in the United States.

Minsky did not emphasize the importance of household debt as his FIH mostly concerned business debt and the banking/financial sectors based on his observation of the real world in his time. Therefore, Minsky’s and Minskyians’ suggestion of “refinancing the markets or institutions” (Minsky 1982: xxi) is mostly understood as the central bank acting as a lender of last resort to provide liquidity to troubled banking and financial institutions. However, Minsky mentions later, although quite briefly, the potentially important role of household debt in the course of business cycle dynamics (Minsky 1996a). Minsky’s idea of refinancing the markets or institutions could be more broadly interpreted as “refinancing the household sector,” and hence consistent with Mian and Sufi’s argument about the need to reduce the debt burden of distressed households through the write-down and restructuring of their mortgage debt to prevent foreclosures.

Mian and Sufi’s studies point out that a main cause of the recession was the reduction of cash flow to businesses due to a dramatic consumption decrease by distressed households who faced a very large fall in housing prices and even foreclosures. This argument is compatible with the Minskyian cash flow characterization of hedge, speculative, and ponzi financing. The lack of demand and resulting cash flow generates what Minsky called speculative and ponzi financing of business, generating a reduction of employment and, through the multiplier process, creating more severe recessionary trends. Mian and Sufi (2014), for example, document the fact that, between 2007 and 2009, counties with the largest drop in net worth experienced the most severe decline in employment in nontradable industries such as retail- and restaurant-related ones. This is due to the reduction of consumer demand induced either by the reduction of net worth or tighter credit constraints induced by the housing price decline as reported by Mian and Sufi (2013): “This knock-on effect on local nontradable employment further depresses local spending” (Mian and Sufi 2013: 1690). And these negative effects spread out to tradable industries (which produce goods for national demand, such as autos and home appliances) as well as the areas that did not experience a housing price collapse (Mian and Sufi 2015b: chapter 5).

As we discussed in section 5, Mian and Sufi (2009) document evidence of increasing inequality, although they do not emphasize the inequality dimension as a cause of household borrowing, unlike post-Keynesians who especially emphasize consumption behavior based on the relative income hypothesis. However, Mian and Sufi’s solution—advocating debt restructuring and write-down of household debt—is based on a wealth transfer between the borrowers (lower-income and lower-wealth households) and the lenders (higher-income and higher-wealth households) due to their finding of significant difference in MPC out of housing wealth between poorer households and richer households. They realize that “such heterogeneity in the MPC implies that the distribution of dollar losses across the economy matters for consumption dynamics” (Mian and Sufi 2013: 1688).

Inequality- and demand-generating processes have long been a centerpiece of post-Keynesian thought. They have long recognized the importance of distribution in creating and sustaining demand, and often advocated distribution favoring wage-earning, lower-income households (naturally borrowers in the present context).²³ The importance of distribution and inequality is well reflected in post-Keynesian analyses of consumption incorporating the relative income hypothesis, emulation, and expenditure cascades as discussed above. Although Mian and Sufi do not emphasize inequality as a cause of household indebtedness unlike post-Keynesians, distribution and demand generation seem to provide another interesting intersection point between post-Keynesians and Mian and Sufi’s understanding of the Great Recession that might be explored.

6. Conclusion

The Great Recession and the unprecedented level of household debt prior to it have provided a great intellectual challenge to the economics profession. In this article, we have surveyed some important post-Keynesian analyses and Mian and Sufi’s series of innovative empirical works. We started with Minsky’s original ideas, still highly relevant, and surveyed Minskyian extensions. Post-Keynesian ideas emphasizing the relative income hypothesis, income inequality, and consumption behaviors were also discussed, followed by the survey of Mian and Sufi’s series of works. Policy perspectives from post-Keynesians and Mian and Sufi were identified and distinguished, and differences and commonalities between them were highlighted.

There are a number of clear and significant differences between post-Keynesians’ and Mian and Sufi’s views largely stemming from their theoretical differences. However, there are some overlaps as well, and empirical results by Mian and Sufi can be seen as providing supportive empirical evidence for some post-Keynesian arguments and emphases such as securitization for credit expansion, differential MPC between borrowers and lenders, the nature of crisis that renders the effectiveness of bank-saving policies, and the linkage between inequality, distribution, and aggregate demand.

Post-Keynesians understand that the Great Recession and household debt accumulation were not simply due to unexpected shocks and an abnormal one-time event. They rightly emphasize that, for an appropriate analysis, we need to provide broad institutional and historical pictures, as instability is a fundamental part of the capitalist system. Mian and Sufi’s works, although they lack such perspectives, provide concrete empirical research that emphasizes a heterogeneity of households, distribution and demand, and the political process. Rather than being simply in conflict due to their theoretical differences, together they seem to provide complementary analyses for understanding the unprecedented household debt accumulation and the Great Recession in the United States. These intersection points, one could hope, provide a venue for fruitful future research endeavors.

Footnotes

Acknowledgments

I would like to thank Engelbert Stockhammer and referees for their very helpful comments to improve the paper. Any remaining errors are mine.

Authors’ Note

Earlier versions of this paper were presented at the annual conference of the Eastern Economic Association, New York, 2017 and the Forth Nordic Post-Keynesian Conference, Aalborg, Denmark.

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author received no financial support for the research, authorship, and/or publication of this article.

ORCID iD

Yun K. Kim .

1

In post-Keynesian and heterodox traditions, even before the crisis, a substantial body of research identified the connection between household debt and macroeconomic stability. See, for example: Palley (1994); Dutt (2005, 2006); Cynamon and Fazzari (2008); .

2

See also Goodhart (2009) and Rogers (2018a, ) for the criticism of DSGE models. Rogers (2018a, 2018b), for example provide, a detailed explanation on the incompatibility between the DSGE model and money and financial markets in general due to the former’s Walrasian Arrow-Debreu general equilibrium microeconomic foundations.

3

Productive enterprises can go through speculative and ponzi financing positions during their operation due to the time lag between the sales of their products and initial devolvement of their products. Therefore, such characterization of firms’ financial positions is understood as current and expected cash flow in terms of firms’ incomes, and current and expected cash commitments in terms of firms’ expenditures. See for example .

4

This argument is based on Kalecki’s profit equation. See : chapter 7)

5

The characteristics of the money manager stage of capitalism in his own words (: 3): “almost all business is organized through corporations; dominant proportions of liabilities of corporations are held either by financial institutions, such as banks and insurance companies, or by mutual and pension funds; the intrusion of a new layer of intermediation, by pension and mutual funds, into the financial structure is prevalent; funds are bound only by contract as to what assets they can own and what activities they can engage in; the stated aim of fund managers is to maximize the value of the investments of the holders of its liabilities; the performance of a fund and of fund managers is measured by the total return on assets, a combination of dividends and interest received and appreciation in per share value.”

6

Although the formal models are not the focus of this paper, it is noteworthy that there has been a significant effort to incorporate Minsky’s ideas in mathematical models. For a survey of recent development, see , which provides an extensive discussion on the various directions researchers have taken to incorporate Minsky’s ideas in models.

7

argues that structured investment vehicle (SIV) funds, after subprime households, are more indebted units than banks. However, note that SIVs were created by banks, and, when their cash flows turned negative during the crisis, they were absorbed by the banks which created them and made the balance sheet of banks worse. This point is not emphasized by Dymski, although he does briefly mention it (2010: 252).

8

Subprime households is the term used by Dymski to refer to “households that purchased homes without pledging any collateral” (: 252).

9

There has been considerable effort and development of formal modeling of post-Keynesian variants to incorporate the consumption behavior of the relative income hypothesis, expenditure cascades, and household borrowing. For example, Setterfield, Kim, and Rees (2016) and Setterfield and Kim (2016) incorporate consumption emulation and expenditure cascades into post-Keynesian growth models. They show that distributional changes between the golden age and the neoliberal regimes, and corresponding changes in consumption emulation behavior via expenditure cascades, can make the economy unstable. Ryoo and Kim (2014) incorporate consumption emulation into the Kaldorian model of income distribution and growth, and analyze macroeconomic instability and cycles due to the interaction of income distribution, consumption emulation, and the lending practices of banks. Kapeller and Schutz (2015) and investigate the effect of consumption emulation behavior on wage-led and profit-led growth and distribution regimes.

10

In light of the argument by Wildauer (2016), it is also interesting to note that, in the mainstream literature, argues that US business cycles are essentially real estate investment cycles based on his observation that, between 1950 and 2014, nine of the eleven recessions were preceded by declines in housing construction.

11

It is noteworthy that the influence of campaign contributions and expansion of subprime lending, and government bailout policies that unfolded during the crisis, were important factors (exogenous shocks in mainstream terms) to the future political unfolding in the United States.

12

High-leverage counties are the “top 10 percent of countries by the increase in the debt-to-income ratio from 2002:Q4 to 2006:Q4. Low-leverage growth counties are in the bottom 10 percent based on the same measure” (: 89).

13

They use the state-level difference on judicial versus non-judicial foreclosure law as an instrument to measure the impact of foreclosures on house prices and economic activities. There is a stark difference in the foreclosure process between judicial and non-judicial property. In judicial foreclosure states, a lender must sue a borrower in court before conducting an auction to sell the property. In non-judicial foreclosure states, lenders obtain the automatic right to sell the delinquent property after providing only a notice of sale to the borrower (: 2588).

14

also test the validity of the financial accelerator approach. According to this approach, the main recessionary force was the reduction of business credit as local banks became more distressed due to mortgage defaults and limited availability of credit. Mian and Sufi’s results are inconsistent with this view, and the authors provide additional explanations of why they believe the financial accelerator effect was not the main force for the recession.

15

See , especially chapter 9.

16

provides a similar argument. He argues that securitization reduces perceived credit risk and that it led to an increased demand for securities products such as mortgage-backed securities.

17

It is important to note that the relaxation of credit supply due to, for example, deregulation and innovation is an example of a credit shock. In post-Keynesian endogenous views, this kind of shock is not necessarily a prerequisite for credit expansion as credit is essentially demand-determined, money is created through the bank lending, and new credit creates deposits (Lavoie 2014b: 187–88). The studies on endogenous money and credit have generated a huge and important literature in post-Keynesian economics, and we do not delve into any details here. For a survey, see : chapter 4).

18

See, for example, for a discussion of the post-Keynesian theory of consumption.

19

In fairness, there have been some attempts to incorporate the relative income hypothesis into the mainstream life cycle hypothesis although it is still not a part of dominant thinking. For example, see .

20

This view is again based on Kelecki’s profit equation which shows that, at the aggregate level, net profits equal investment plus net export plus government’s deficit plus consumption out of profit income minus saving out of wage income.

21

In this program, the government paid car dealers $3,500 to $4,500 for every fuel-inefficient vehicle traded by consumers for more fuel-efficient vehicles (: 1).

22

There are very significant differences in available resources for research. One of the reasons Mian and Sufi and other mainstream economists could perform such large micro-data analyses is their resources availability, which is mostly not available for post-Keynesian and heterodox researchers.

23

There is a vast literature on this subject, often classified as wage-led vs. profit-led demand and growth. See, for example, Blecker (1989, 2002) and Bhaduri and Marglin (1990b, ), among many others.

Author Biography

Yun K. Kim is Assistant Professor of Economics at the University of Massachusetts-Boston. He has worked on heterodox maceoeconomics and macroeconomic implications of houshold debt, and has numerous articles published within the areas.

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