Maybe credit really does drive growth. Maybe excess credit really does force a boom to turn into a bust. But no one has yet come up with a really compelling, testable explanation for how that happens.Sure they have, Noah, though perhaps not expressed in the particular model you require. Cost. The explanation is cost: the rise of financial cost. Cost, Noah.
Need I repeat myself?
Down the page a bit, Hansen writes:
Also there is little question that consumer credit is becoming a larger and larger element in the economy - but:Yes, Hansen, but it's tough to untangle. A lot was going on around 1980: deregulation, supply-side economics, you name it. Credit use was only one part of it all (and credit use was enhanced by some of it). And consumer credit was only one part of credit.
- prior to 1980 it seems there was a positive correlation between consumer credit to gdp ratio and GDP growth;
Could it be true that at some point of growth, consumer credit growth works against GDP growth?
- since 1980, consumer credit to gdp ratio has had an inverse correlation to GDP growth.
Further yet down the page:
My opinion is that too much consumer credit outstanding constrains economic growth, and too little consumer credit outstanding constrains economic growth. The optimum consumer credit levels are likely a sliding scale based on a slew of dynamics - and I suspect one of the larger dynamics is rate of inflation (the higher the rate of inflation, the higher the optimum level of credit).Glad to see I'm not the only one who says there must be an optimum level of credit. But, fuck, it's not only "credit outstanding" you have to think about. There are also the new uses of credit, the ones that add to credit outstanding, just like deficits add to the Federal debt.
New uses of credit put money into the economy when the money is spent. The borrower is left with a debt (or "credit outstanding" as Hansen says). Then, when the monthly payments begin, money starts coming back out of the economy. The new use of credit, the borrowing and spending, increases economic activity. Repayment of the debt reduces it.
So...
- The amount of credit we have in use use is called debt. Putting new credit to use adds to that debt.
- A new use of credit provides boost to the economy. Paying down the resulting debt creates a more or less "equal and opposite" drag on the economy. And
- Debt, oddly, is not the problem; repayment is. But you can't have one without the other.
Super simple stuff.
4 comments:
So, yes: "too much consumer credit outstanding constrains economic growth". But no, it's not true that "too little consumer credit outstanding constrains economic growth." Rather, it is too little new use of credit that constrains economic growth, by keeping spending smaller than it would otherwise be.
Note that too much credit outstanding constrains growth by increasing cost... by increasing financial cost, which means that more income is income to finance rather than income that rewards the production of output. We see the financial sector growing at the expense -- literally -- of the nonfinancial sector.
Hi Art,
Here is a graph that may help to explain what changed in the credit market around 1980.
https://fred.stlouisfed.org/graph/fredgraph.png?g=p1fn
The black curve is Total credit compared to GDP
The red curve at the bottom is bank credit to GDP. That is the amount of credit deposit institutions contribute to the black curve total
The blue line is the credit funded by non-banks (i. e. the private markets)
It looks like prior to 1980 the blue line was pretty flat and any increase in credit relative to GDP was being funded by deposit institutions.
And then after 1980 all that mushrooming credit came mostly from non-bank lenders. Or to put it another way had private-market-funded credit remained flat after 1980 as it did before 1980 then the Ratio of debt to GDP would be not much higher than it was in 1980.
I realize you were talking about consumer credit, not total credit. I don't know how easy it would be to break down consumer credit into bank and non-bank lending.
Hi Jim. Thanks for the graph.
I usually try to refer to "the financial sector" rather than "banks" and "non-banks" and "deposit institutions". I know this makes my stuff non-technical and I know that the cause of this is my lack of knowledge.
In particular I don't understand why you find it important to focus on banks versus non-banks etc. I know it would have an effect on corrective policy, but I don't know what the "it" is.
If you could explain this to me it would help a lot.
//
"It looks like prior to 1980 the blue line was pretty flat..."
I would want to say that before the mid-60s, blue and black were both increasing, but in the mid-60s they started decreasing, and this change was the consequence of "the great inflation".
In the 1970s, lenders and borrowers adjusted to the inflation (as Friedman said we would!) and black & blue started rising again. Then as the great inflation came to a close we got the "all that mushrooming credit" increase, because NGDP growth was slowing as the inflation rate came down. (Remember that I use a different calculation for real debt than for real gdp.)
I see that my inflation-related story appears not to apply to the red line, and this I cannot explain.
//
"Or to put it another way had private-market-funded credit remained flat after 1980 as it did before 1980 then the Ratio of debt to GDP would be not much higher than it was in 1980."
Or, banks would have made up a lot of the difference by increasing their lending... unless banks are constrained by regulations that don't apply to non-banks. But I don't imagine policymakers worried very much about the growth of debt.
Thanks again Jim.
"I don't understand why you find it important to focus on banks versus non-banks etc. "
If that graph doesn't reveal the important difference between lending by deposit institutions and lending by everybody else I can't imagine what would. It looks to me that if the blue line had continued as it was trending before 1980 the total debt would be about half of what it is today. That is enormous
"I know it would have an effect on corrective policy, but I don't know what the "it" is."
That is the big question, but this you can be sure of, the "it" is not the policies that are designed to impact on the growth of red curve.
As a small example of a change 40 years ago, in the 1970s things like Payday Lending and Title Lending were considered criminal enterprises usually run by the Mafia. Then the law was changed and today almost every strip mall in America has a Payday Loan or Title Loan outlet. And I can assure you the borrowers are not doing it because the govt allows them to deduct interest on their taxes.
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