"My interpretation is different – very different. I call it the destruction of shared prosperity hypothesis. This view is not represented in mainstream economic discussions because it challenges the fundamental theoretical foundations of mainstream economics which are shared by both hardcore Chicago School (freshwater) and softcore MIT School (saltwater) neoliberal economics.

My argument is that around 1980 the U.S. adopted a fundamentally flawed economic paradigm. From 1945 through to the mid-1970s the U.S. economy was characterized by a “virtuous circle” Keynesian growth model built on full employment and wage growth tied to productivity growth. The political triumph of Ronald Reagan enshrined a new economic paradigm that abandoned full employment and severed the link between wages and productivity growth.

The new paradigm was fundamentally flawed. One flaw was that it relied on debt and asset price inflation to fuel growth instead of wages. A second flaw was the model of globalization which created an economic gash in the form of leakage of spending on imports (the trade deficit), leakage of investment spending offshore, and leakage of manufacturing jobs offshore. These twin flaws created a growing demand gap.

That is where finance enters the picture as its role was to fill the demand gap. Financial deregulation, regulatory forbearance, financial innovation, financial mania, and plain vanilla financial fraud kept the economy going by making ever more credit available, However, as the economy cannibalized itself by undercutting income distribution and accumulating debt, it needed ever larger speculative bubbles to grow. The house price bubble was simply the last and biggest bubble and was effectively the only way around the stagnation that would otherwise have developed in 2001.

The house price bubble delayed the onset of stagnation but at a cost. When it burst it created a financial crisis because of the scale of financial excess. Moreover, it also makes it harder to escape stagnation now because of the scale of debt burdens and the extent of destruction of credit-worthiness."

Thomas Palley, an AFL-CIO economist, is a fellow at the New America Foundation.

Read more at http://www.nakedcapitalism.com/2012/04/from-financial-crisis-to-stagnation-an-interview-with-thomas-palley.html#Us9vZbqoKYzRIuh1.99