The Institute Blog

INET Spotlight - Credit is What Credit Does: Finance and Economic Growth Uncoupled

Contrary to conventional wisdom economics is not about money.

“The cutting edge models have no banking sectors at all,” says Dutch economist and INET grantee Dirk Bezemer. “Models that central banks use have no banks. Just let that sink in.”

Bezemer has conducted a careful analysis of the financial sector that provides a much-needed change from the usual macroeconomic models. In his recent presentation at INET Berlin, Bezemer gave an in-depth explanation of how to create a socially useful financial system.

His answer is simple: “Credit is what credit does.”

“Most of our credit system does not support economic growth in the sense of supporting transactions in goods and services,” he explains. “Most of our finance system, most bank loans, support increased asset prices, which have a number of detrimental effects on the economy.”

Debt going to asset markets can be helpful at a low level of debt (when overall debt is about 100% of GDP, Bezemer suggests. The U.S., by comparison, is now at more than 400%.). But when debt gets too high, servicing it becomes a big drain on the real economy. And this means lower economic growth.

But orthodox macroeconomic models won’t tell you any of this. “There are no models tracing credit, so a credit crisis will come out the blue,” Bezemer says. “We can do better than that.”

Bezemer shows that “on average, at higher levels of credit going to asset markets, there is a negative, inverse relation between international financial flows and fixed capital formation. And therefore you have lower growth.”

Supporting this credit addiction has very obvious symptoms. “It’s not a coincidence that we have excessive speculation in food prices right now,” he says. “All that money is still around.”

The solution, according to Bezemer, is pretty simple. We must greatly shrink the financial sector, while preserving the essential functions of credit allocation to the real economy. As Bezemer writes in his recent article for Eurointelligence, “The threat to growth today is not a shrinking of the financial sector, but it enormous size.”

Traditional approaches to this problem – austerity and quantitative easing (QE) – won’t work for precisely this reason, he suggests. Austerity starves the real sector while QE-like measures flood asset markets with credit. “We are doing the exact opposite of what we are supposed to do,” Bezemer says. “We need to get more credit to the real sector and less to the financial sector.”

“The mantra is that if we let banks go bankrupt, that will ruin the economy,” he adds. Yet, “this is a nifty inversion of the truth: it is precisely the support for banks’ balance sheets that will prolong our economic woes. But to see this, you need to think about balance sheets – which macroeconomics almost forbids one to do.”

So macroeconomics may not be about money after all. But Bezemer makes a convincing case that it needs to be.

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