Financialization Essay

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Working Paper No. 525
Financialization: What It Is and Why It Matters* by Thomas I. Palley
The Levy Economics Institute and Economics for Democratic and Open Societies
Washington, D.C.
December 2007

Paper presented at a conference on “Finance-led Capitalism? Macroeconomic Effects of Changes in the Financial Sector,” sponsored by the Hans Boeckler Foundation and held in Berlin,
Germany, October 26–27, 2007. My thanks to conference participants for their valuable suggestions. All errors in the paper are my own. Comments may be sent to The Levy Economics Institute Working Paper Collection presents research in progress by
Levy Institute scholars and conference participants. The purpose of the series is
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There are also indications of increased financial fragility. Internationally, fragility was evident in the run of financial crises that afflicted the global economy in the late 1990s and early 2000s, and it has surfaced again in the recent U.S. sub-prime mortgage crisis that spread to Europe.
Furthermore, there are serious reservations about the sustainability of the financialization process. The last two decades have been marked by rapidly rising household debt-income ratios and corporate debt-equity ratios. These developments explain both the system’s growth and increasing fragility, but they also indicate unsustainability because debt constraints must eventually bite. The risk is when this happens the economy could be vulnerable to debt-deflation and prolonged recession.
These macroeconomic concerns are compounded by concerns about income distribution. Thus, the era of financialization has witnessed a disconnection of wages


from productivity growth, raising serious concerns regarding wage stagnation and widening income and wealth inequality (Mishel et al. 2007).
The financialization thesis is that these changes in macroeconomic patterns and income distribution are significantly attributable to financial sector developments. Those developments have relaxed constraints on access to finance and increased the influence of the financial sector over the non-financial sector. For households this has enabled greatly
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