Fault Lines

Rajan, who had warned about financial system risks at the 2005 Jackson Hole conference and was dismissed at the time, argues that the 2008 crisis had deep causes in political and economic imbalances rather than in the behaviour of bankers alone.

His first fault line is domestic American inequality. He argues that stagnant incomes for most households created political pressure that both parties addressed by expanding credit access, particularly housing credit, rather than by addressing education and income directly, because credit expansion is politically easier than redistribution. He traces this through Fannie Mae and Freddie Mac's affordable housing mandates and the regulatory encouragement of subprime lending.

His second is the export-led growth model. Countries including Germany, Japan and China built economies dependent on external demand and accumulated surpluses that had to be invested somewhere, which flowed into American assets and depressed yields, encouraging the search for yield that produced the structured credit market.

His third is the mismatch between financial systems with different structures, and the absence of adequate safety nets in the United States, which makes recessions politically intolerable and forces central banks to respond to every downturn with monetary stimulus, ratcheting risk-taking upward over successive cycles.

The argument is analytically serious and Rajan's forecasting record gives it standing. Critics dispute the inequality-to-credit-expansion causal chain, arguing the empirical support is weaker than presented, and the political economy sections are argued rather than demonstrated. The identification of global imbalances as a structural driver has been widely accepted.