A Look at Causation in Bezemer and Hudson's "Finance is Not the Economy"

Bezemer and Hudson:

In Figure 2, based on calculations by Dirk Bezemer, Maria Grydaki, and Lu Zhang (2016), we plot the correlation of income growth with credit stocks scaled by GDP. This provides a proxy for the growth effect of credit over time. The trend is downward from the mid-1980s, and from the 1990s the correlation coefficient is not significantly different from zero. Credit was no longer “good for growth,” as many had for so long believed (from King and Levine 1993 to Ang 2008).

A major reason for this trend was that credit was extended increasingly to households, not business.

The growth effect of credit has been downward since the mid-1980s, they say. The reason they give for the decline is that "credit was extended increasingly to households". The argument makes sense. I mean, households are consumers, not producers. It's almost intuitive, now they point it out.

I hate arguments like that. Dangerous arguments. Arguments that make so much sense you think you don't need to actually look and see if they are supported by the data.


Consider household debt relative to other, more comprehensive measures of debt:

Graph #1: Household Debt as a Percent of Private NonFinancial (red) and Total Debt (blue)

The blue line shows household debt as a share of total credit market debt: drifting downward from a 30% share in the 1960s. Yes, up a little just before 1980, but that didn't cause any Global Financial Crisis. Yes again, up a little after 2000. By the timing of it, you might say this was the increase that caused the crisis.

And yet, household debt runs higher on the graph from the early 1960s to the early 1980s than it was at its pre-crisis peak. Household debt was a smaller share of total debt on approach to the crisis than it was in the early 1960s and the two decades that followed. Given this fact, my view can only be that the increase in total debt was the real cause of the crisis. Household debt just went along for the ride.


The red line on the graph shows household debt as a share of private non-financial debt. Private non-financial consists of non-financial business debt and household debt. For half a century, from the early 1950s to the early 2000s, household debt was about half of private non-financial debt. The other half was non-fi business debt.

It varied, of course. Household debt ran as low as 46% and as high as 54% of private non-financial. But until the 2000s it was always within four points of the 50% level.

Looking at that red line on Graph #1, you could say that the household share has increased since the mid-1980s. There was a brief dip in the latter 1990s, but the trend was upward from the mid-80s to 2006.

Bezemer and Hudson say the "growth effect of credit" has been falling since the mid-1980s. They say that the growing household share is responsible for this decline. But in the mid-80s, household debt was at the bottom of its normal range. It had nowhere to go but up.

Household debt was on the low side of private non-financial for two decades, from 1970 to 1990. After it escaped the low side, climbing above the 50% level in 1991, it remained within its normal range (below 54%) for a decade.

Based on Graph #1 we can say Bezemer and Hudson seem to suggest that the increase from low normal to high normal was the problem, and that the fall of the growth effect began the moment household debt started rising from bottom in the mid-80s. But that view just doesn't make sense.


The household share was at bottom in the mid-80s. Are Bezemer and Hudson saying it was an insufficiency of household debt that caused the "growth effect" to fall? Obviously not. But perhaps they should.

When household debt reached peak share in the mid-90s, it was no higher than it was in the mid-60s. It is interesting to note that both of those highs occurred during good economic times.

Graph #5: Household Debt relative to Private Non-Financial Debt

This coincidence should raise doubt about Bezemer and Hudson's dangerous argument that a high household share of debt is the cause of our economic troubles.

If our troubles started in the mid-80s, as Bezemer and Hudson say, then perhaps the source of troubles is not that household debt is a high percentage of private non-financial, but that household debt is just plain high, like private non-financial debt, and private financial debt, and credit market debt in general.