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A few years ago, while looking at the Journal of Economic Literature, the weighty compendium that tracks economic research, the economist James Galbraith spotted a curious omission. Although the journal monitors work on income inequality and on financial stability, he explains in his new book, before the recent financial crisis, "there was (and is) no category for work relating inequality to the financial system."
Part of the problem is academic tribalism: the type of economists who study inequality tend to be interested in micro-level issues of poverty rather than macroeconomic issues, such as the global supply of credit. But the gap also reflects an intellectual illusion that prevailed during the decade before 2007. Back then, most Western economists believed that the world had entered an era in which the business cycle had flattened out and financial instability no longer mattered -- "the great moderation," it was called. In particular, many hoped that markets were self-healing; bouts of financial excess were unlikely to last because they would quickly self-correct. Before 2007, Galbraith writes in Inequality and Instability, "there was practically no study of credit and therefore no study of financial instability at all. In a discipline that many might suppose would concern itself with the problems of managing an advanced financial economy, the leading line of argument was that no such problems could exist."
How times change. These days, the gurus who compile the Journal of Economic Literature need only turn on the television or open a newspaper to see why inequality and financial stability matter deeply, not just as separate issues for their own sake but also in connection with each other. Never mind all the handwringing about the failures of financial policy before 2007 or the scramble by regulators to devise new rules to make the financial system safe again. These days, there are equally furious rows about inequality: in Congress between Democrats and Republicans over the "millionaires' tax" and, of course, in the Occupy Wall Street movement, whose adherents complain about both the excesses of finance and the privileges enjoyed by the top one percent.