About the Interview
Carmen Reinhart and Kenneth Rogoff tell the history of financial crisis as a tale of excessive public debt. But what more commonly drives financial instability, says Moritz Schularick, is excessive private debt. Financial crises are credit booms gone bust. Schularick and his collaborators compile a long-run data set of disaggregated credit flows, separating loans for productive investment from loans for the purchase of existing assets. A marriage of economic history and modern statistical methods to investigate the role of finance in the macroeconomy -- this is new economic thinking.
About Moritz Schularick
Moritz Schularick is professor of economics at the John F. Kennedy Institute of the Free University of Berlin, Germany. His current work focuses on credit cycles, the determinants of financial crises, and the international monetary system. More...
Comments
In general, in a market, loans for productive purposes are driven by and demand for what is being produced. Demand would be final consumption by the consumer. To the extent the consumer demand is inflated by loans that the consumer cannot repay, it will drive loans for productive purposes that will not be profitable because the final demand will not be there. Loose consumer lending practices will lead not only to loss of loan principal and interest at the consumer level, it will cause loss of principal and interest at the productive business level even though the productive loans appeared to be sound when made. Lose consumer lending skews demand signals in the market.
Of course, the economy is not a closed system so exogenous factors can make this not true in particular instances. For example, if a company uses the productive loan to create manufacturing capacity that is more efficient and capable of supplying goods at profit even when consumer demand generated by loans that have not been paid back are factored into the equation, then it is still a winner for the economy though not the lender to the consumer who was not repaid. This is the effect of innovation. It can save the economy from its own poor economic decisions.
Think about this thought experiment, what if loans were not made to consumers. In other words, consumers had to first earn and save to make a purchase rather than borrow, purchase and then pay off the loan? Then there would no risk that the loan would not be repaid. The demand that producers saw that lead to the productive loan would be more reliable in that there would not be a risk of drop off of demand caused by mass consumer default caused by improvident loans (like the subprime loans). Would this not tend to increase economic stability? It would tend to constrain the size of bubbles and reduce the losses when they burst?
Further, money is a commodity in many ways like any other. The cost of money should reflect supply and demand by those who create goods or services if the money transmitted supply and demand signals are to accurately transmit accurate supply and demand signals in the market. If the government prints more money, it devalues the money obtained by producing goods or services (work) and demotivates them to work and save. It also skews the demand signals for the things bought with the additional printed money causing investment in things (like housing driven by subprime and also Agency guaranteed lending) for which there is not real demand by the productive members of society. Without production, there are no goods and services. You want to encourage production, not discourage it by taking away the fruits of production that are saved, money, by printing money and giving or lending it to those who would otherwise not have it because their economic contribution did not warrant it. This is the essential argument for sound money. Sound money is a nice concept but impossible to achieve unless the voters understand the need. It is the enemy of governments because it constrains what they can do.
Finally, leverage can kill. Loans made for productive purposes or to consumers who can easily repay the loan no matter what happens to demand or their job will have a less deleterious effect on the economy. For a business that over invests and does not make a sufficient return to repay the loan, the business losses its investment which will constrain its future investment ability. That is the gamble of investing. The consumer will similarly be constrained in future consumption. Once something is lost or destroyed, it no longer exists. But these losses will have a lesser overall effect on demand and on the economy than loans made at higher leverage.
For example, if you have $100 in savings in the bank, borrow $10, you can always pay it back out of savings. It is just that you will now have only $90 left which will have an depressing effect on the amount you are willing to borrow and spend in the future. If you have $100 in savings, borrow $1000 and don't pay it back, that is a horse of an entirely different color in that it will have a much more extreme effect on future economic behavior.
Like my grandmother said, moderation is all things is best.
Delighted to see an INET grant being awarded to some economists who understand that credit is the most important macroeconomic variable in modern economies (unlike most Central Banks/Treasuries which still use macro-models that don't include banks and use IS-LM)
Moritz, have just read your AER paper 'Credit Booms Gone Bust' - sounds like you are developing a great data-set. I wonder if you are aware that there is an emerging field of heterodox economists that goes beyond the Mishkin 'credit view' to be more of a 'credit theory of money'. These include Richard Werner at Southampton who developed a dis-aggregated credit equation as far back as 1997 and used it for econometric work on Japan to explain high growth in the 1980s and the stagnation of the 1990s. Others in this field include Michael Hudson, Dirk Bezemer and post-keynesians like Steve Keen who has also developed a 'credit' rather than 'financial' accelerator, based upon Minksy (INET also funding him so I hope so!).
Look forward to seeing more of your work and Central Bank's and Ministry of Finance getting beyond just raising capital reserves and actually getting more interventionist in terms of quantity and quality of credit tools. Adair Turner and Andy Haldane are talking about it but Vickers review has ignored it in the UK context.
Josh Ryan-Collins
new economics foundation
London
www.neweconomics.org/projects/monetary-reform
Is Irving Fisher's Booms and Depressions cited? If not, is his paper in Econometrica cited?
In addition to Keen look at Werner's "New Paradigm in Macroecomics". He has a good data set on "non GDP lending" into land speculation and the building industry. He is able to explain much of the mystery of the Japanese decline including the decrease in the multiplier. This is an important but overlooked contribution to the needed reform in economics.
"A marriage of economic history and modern statistical methods", what a frightening prospect.
Yet another highly theoretical project!
Doesn't Mr Schularick know that humans do not learn from the past? You don't need to search for historical data to see that, the evidence is all around us.
Professor Schularick laments the absence of data, generally. Most importantly, I suggest, is the failure of government to track land values as a distinct component of property markets. There was no "housing boom" in the United States. Even a cursory look at the skyrocketing increase in land-to-total value ratios over the last property market cycle reveals that the increase in prices were increases in land price.
The reason why land prices act as they do is rather straightforward. Absent an annual rate of taxation approaching 100% of the potential annual rental value of a location, the net imputed rental income stream is capitalized by market forces into a selling price. And, the rewards for landowners are to hold land off the market for speculative gain. Thus, we see the strange graphical representation of a leftward leaning supply curve for land, such that only a dramatic crash returns the market to something approaching general equilibrium (albeit with heavy social costs in the form of widespread unemployment, poverty and the under-utilization of capital goods).
Kudos to INET for sponsoring Moritz in his important research, and to Moritz for undertaking such useful work.
As a "non-credentialed economic thinker using the methods of other disciplines" , I will be very interested, especially, in the outcome of researches into where the credit goes that creates financial booms-that-go-bust.
Can I suggest we call them "bubbles", instead? An economic boom is too often received emotionally as a good thing, which contributes to the difficulties of keeping them from forming in the first place. Bubbles are received analytically, as always an unsustainable condition of excess.
Everybody wants to get a boom going, and keep it going for as long as we can.
Nobody wants to live inside a bubble.
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