Simon and Thomas: Simon

Reading Thomas Philippon's PDF Has the U.S. Finance Industry Become Less Efficient? the other day, I paused to review Simon Johnson's 2009 post The Nature of Modern Finance. This part struck me:

There is a great deal of research that finds finance is positively correlated with growth, but this work has a couple of serious limitations – if you want to derive any robust implications for policy.

First, it is about the amount of financial aggregates (e.g., money or credit, relative to GDP) rather than the share of financial sector GDP in total GDP. I know of no evidence that says you are better off with a financial sector at 8% rather than, say, 4% of GDP.

Johnson raises other doubts about the relation between finance and growth, but I am focusing here on just the first of them.

A great deal of research in this area deals with financial aggregates, he says. Little or none deals with the size of the financial sector relative to GDP.

Thomas Philippon could have seen Simon Johnson's post and thought: Well let me see if I can fill that gap, for this is exactly what Philippon has done. But what Philippon does is not what I do.

I look at the monetary aggregates. But I don't prefer to look at money or credit, or total debt either, compared to GDP. People quite often tell me this is what I ought to be looking at. But my focus is elsewhere.

I compare money aggregates to money aggregates: Debt per dollar, for example. My graphs show the skewing within money, the stress and the cost within money that are created by thinning out a few dollars of base money into many dollars of debt.

GDP is not a result of the efforts of finance. The monetary aggregates are.