Saturday, April 28, 2012

"It was private borrowing, not public borrowing, that created the mess."

From Paul Krugman's Leveraging, Deleveraging, and Fiscal Policy:

Spain and Ireland were running budget surpluses, not deficits, before the crisis. It was private borrowing, not public borrowing, that created the mess.

Yes, absolutely it was.

But, say some commenters, this was nonetheless malfeasance on the part of the authorities; they should have been running even bigger surpluses to offset the private credit bubble.

Does that work? No. If you look at a graph of private versus public debt, and think about how the trend fits with economic performance, this is where you end up:

When private debt is relatively low, it has room to expand. And when private debt expands, the economy grows well. But when private debt expands, it becomes relatively high. And when private debt is relatively high, it chokes off growth.

Graph #1: Total Nonfinancial Nonfederal debt relative to the Gross Federal Debt
The initial increase corresponds to the "golden age"
The post-1994 increase corresponds to the "macroeconomic miracle"

That being the case, the evidence says big government surpluses do not effectively offset big private deficits. Moreover, making the government surpluses bigger makes private debt relatively higher, and that only makes things worse.

Yes, it was private borrowing that created the mess.


noiln said...

Economics Development is a process whereby an economy’s real National Income Increases over a long period of time, and if the rate of development is greater than the rate of population growth, then pre capital real income will increase. Banks are the custodians and distributors of liquid capital which is the life blood of our commercial and industrial activities.

Greg said...

That sounds like a line from a commercial for Citi Bank or something noiln!! They should hire you as a pitchman.

Truth is we dont NEED banks to do the function you describe, more specifically we dont need THESE banks, run by THESE.......... "CUSTODIANS". We would all be better off by measurable proportions if every current central banker and head of large financial institution simply became "custodians" AT their bank and not OF their bank.

The Arthurian said...

If we could get that blue line down between 1 and 2, banks would still be the custodians and distributors of the life blood of our economy, but the total cost of it would be much less, as would the risk of cascade failure.

Noiln, you do seem to observe that there may be limits to how much financial cost an economy can bear, before the cost does more damage than finance provides benefit.