Tuesday, January 30, 2018

There is one thing...


Reading Credit, Financial Conditions, and Monetary Policy Transmission, the "preview" PDF from the AEA...

It's really good:

[We] study the influence of private nonfinancial credit in the dynamic relationship between financial conditions and monetary policy and macroeconomic performance in the U.S. from 1975 to 2014. Specifically, we examine the role of private nonfinancial credit in conditioning the response of the U.S. economy to impulses to financial conditions and monetary policy.

They want to see if high debt creates problems. Nothing is more important at this stage of the game. Nothing.

We use a broad measure of credit to households and nonfinancial businesses provided by banks, other lenders, and market investors. We follow conventional practice to measure high credit by when the credit gap (credit-to-GDP ratio minus its estimated long-run trend) is above zero...

That's what we looked at yesterday, how they figure the credit gap. I'm okay with it now. Sort of.

In addition to credit growth and the credit gap, they use a "financial conditions index":

Financial conditions indexes are summary measures of the ease with which borrowers can access credit.

A brief description:

To incorporate financial conditions, we construct a financial conditions index (FCI) combining information from asset prices and non-price terms, such as lending standards, for business and household credit, following Aikman et al (2017). In studies of monetary policy transmission, FCIs represent the ease of credit access, which will affect economic behavior and thus the future state of the economy.

Also:

Periods when the FCI is low (indicating financial conditions are tighter than average) are associated with worse overall economic performance: the unemployment rate is higher and rising, and real GDP growth is significantly lower...

And:

a positive impulse to financial conditions stimulates economic activity, but also leads over time to a build-up in credit and, ultimately, subpar growth.

You get the picture. So what did they learn from their study?

We find the following results. First, credit is an important channel by which impulses to financial conditions affect the real economy. We find that positive shocks to financial conditions are expansionary and lead to increases in real GDP, decreases in unemployment, and increases in the credit-to-GDP gap...

They find that policy works. But not always:

However, when the credit-to-GDP gap is high, initial expansionary effects dissipate but lead to further increases in credit, which, in turn, lead to a deterioration in performance in later quarters... When credit growth is sustained and the credit gap builds following looser financial conditions, the economy becomes more prone to a recession...

In a high credit environment, instead of getting more economic growth you get more credit growth and more recession. But it is not only pro-growth policy that is undermined by high levels of debt; restraint is undermined as well:

When the credit gap is low, impulses to monetary policy lead, as expected, to an increase in unemployment, a contraction in GDP, and a decline in credit. However, when the credit gap is high, a tightening in monetary policy does not lead to tighter financial conditions, as expected, and has no effect on output, unemployment, and credit...

In other words, a high level of debt makes policy less effective.

We test whether the transmission of monetary policy to forward Treasury rates differs significantly between high and low credit gap periods, and find there is less impact in high credit-gap states...

In other words, a high level of debt makes monetary policy less effective.

In addition, we evaluate whether the nonlinearities in economic performance may reflect factors other than credit, such as whether financial conditions are tight or loose, but find that the nonlinear effects are related to loose financial conditions only when credit is high, reinforcing our findings that credit has an independent role in explaining performance.

These findings are simply astonishing! Remember, it's not just some clown in the corner making graphs for his blog who is coming up with these things. It is people from the Bank of England and the Federal Reserve: central bank economists, saying things I would be happy to say. Things I am happy to repeat.

But then, they also say:

These empirical results can be useful for structural models that could link credit to financial conditions or monetary policy, and allow for nonlinear effects of shocks to economic performance based on credit.

Useful for making models? I was hoping for so much more: They want to see if high debt creates problems. Nothing is more important...

They point out that their result, their

empirical result ... supports the literature on the role of credit ... starting with Bernanke and Gertler (1989).

Since 1989. This is 2018. It's 29, almost 30 years they've known that a high level of debt (or credit, as the bankers call it) creates problems for the economy. Isn't it time to use these findings for something other than making models? How long do we have to wait for that to happen?

And there is one thing that I cannot get past. The last sentence in the last paragraph:
Taken together, our results suggest that theory and policy should address the role of credit in the transmission of monetary policy and financial conditions. In particular, economic dynamics of particular relevance to policymakers appear significantly different when credit-to-GDP has grown significantly faster than average for some time. This dynamic bears on the costs and benefits of using monetary policy to lean against the wind and prevent the buildup of credit (Svensson (2016), Gourio, Kashyap, and Sim (2016)). Moreover, it points to the benefit from additional research evaluating the potential for macroprudential policies to reduce the vulnerabilities associated with excess credit.

It's all good, right up to that last sentence, where the cat escapes the bag. They think it would be good to come up with "policies to reduce the vulnerabilities associated with excess credit."

Not policies to prevent credit from rising to the level of "excess credit". No no. Policies to reduce the vulnerabilities, so that we can have excess credit and not be so exposed to the troubles that it creates. They want to be able to expand credit further.

Dammit. They still think like bankers.

3 comments:

Salmo Truttra said...

It's not about credit excesses (credit displacing the lack of income gains). It's about frictionless financial perpetual motion which requires that income not spent be reintroduced into the economy. However, all commercial bank-held savings (+ 10 trillion dollars) are un-used and un-spent (by the BOE’s working definition). This represents a huge leakage in Keynesian National Income Accounting. This fact destroys money velocity. I.e., the DFIs always create new money when they lend/invest. They do not loan out existing deposits saved or otherwise.

The skewing of incomes exacerbates the stoppage in the flow of savings into real-investment outlets. It also reduces AD, which is necessary for high levels of CAPEX, for high levels of economic competitiveness, for increased productivity.

The payment's system is literally inverted (in all sorts of different ways). Phillip George’s math model proves this. Leland Pritchard’s accounting model predicted this in 1961 (in a meeting of the most prestigious Ph.Ds of that time).

The economy could grow out of the deficits, like after WWII, but we won’t (because bank-held savings are lost to both consumption and investment). The most likely beginning of the next economic depression is 2020.

Salmo Truttra said...

The last 60 + years were accurately predicted, e.g., stagflation, secular stagnation, money velocity, etc. And the future is known. This was documented in 1961:

“Should Commercial banks accept savings deposits?” Conference on Savings and Residential Financing 1961 Proceedings, United States Savings and loan league, Chicago, 1961, 42, 43.

As Dr. George Selgin told me:

“None of this would matter if the Fed acted as an efficient savings-investment intermediary, as commercial banks are able to do, at least in principle.”

“This is nonsense, Spencer. It amounts to saying that there is no such things as 'financial intermediation,' for what you claim never happens is precisely what that expression refers to."

Princeton Professor Dr. Lester V. Chandler, Ph.D., Economics Yale, theoretical explanation was:

“that monetary policy has as an objective a certain level of spending for gDp, and that a growth in time (savings) deposits involves a decrease in the demand for money balances, and that this shift will be reflected in an offsetting increase in the velocity of demand deposits, DDs.”

His conjecture was correct up until 1981 – up until the saturation of financial innovation for commercial bank deposit accounts I.e., the saturation of DD Vt according to Dr. Marshall D. Ketchum, Ph.D. Chicago, Economics

"It seems to be quite obvious that over time the “demand for money” cannot continue to shift to the left as people buildup their savings deposits; if it did, the time would come when there would be no demand for money at all”

Thus, as Dr. Leland J. Pritchard, Ph.D. Chicago - Economics, M.S Statistics, Syracuse predicted after the passage of (1) the DIDMCA of March 31st 1980, i.e., coinciding with his prediction of the (2) "time bomb", the widespread introduction of ATS, NOW, & MMDA accounts, that money velocity had reached a permanently high plateau.

Professor emeritus Pritchard never minced his words, and in May 1980 pontificated that:

“The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”.

Take note. DFIs do not loan out existing deposits saved or otherwise. All bank-held savings are un-used and un-spent. They are lost to both consumption and investment. This is the sole cause of Harvard Professor Dr. Alvin H. Hansen’s, Ph.D., Economics, Brown University, secular stagnation.

As Dr. Pritchard’s (a man 30 times smarter than Albert Einsten), economic syllogism posits:

#1) “Savings require prompt utilization if the circuit flow of funds is to be maintained and deflationary effects avoided”…
#2) ”The growth of commercial bank-held time “savings” deposits shrinks aggregate demand and therefore produces adverse effects on gDp”…
#3) ”The stoppage in the flow of funds, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods.” Circa 1959

Nobel Laureate Dr. Milton Friedman was one-dimensionally confused: From Carol A. Ledenham’s Hoover Institution archives: Friedman pontificated that: “I would (a) eliminate all restrictions on interest payments on deposits, (b) make reserve requirements the same for time and demand deposits”. Dec. 16, 1959. I.e., the iconic Friedman conflated stock with flow (not knowing as well, a debit, from a credit, i.e., flow).


The Arthurian said...

Salmo,
Fascinating notes.

I followed the link to your Blogger profile and took a quick look at your blogs. I want to go back and take a good long look at what you have there.

In the comments above you said:
"It's not about credit excesses (credit displacing the lack of income gains). It's about frictionless financial perpetual motion which requires that income not spent be reintroduced into the economy. However, all commercial bank-held savings (+ 10 trillion dollars) are un-used and un-spent (by the BOE’s working definition). "

My problem with "frictionless financial perpetual motion" (nice phrase!) may be a little different than yours. My understanding is incomplete, but banks want and need deposits for some reason. I think they want and need deposits so that they can make loans, and I think this must be true even though banks "do not loan out existing deposits saved or otherwise."

The Fed is not the only one who puts money into the economy. All lenders do that.

Lending and spending have different consequences. If you spend money into the economy you do not increase the number of dollars on which interest must be paid. Only if you lend money into the economy do you increase the number of dollars on which interest must be paid. That number of dollars, together with interest rates, determine financial cost.

Financial cost is not frictionless. It is a burden to the non-financial sector.

I don't have a problem saying that "income not spent [is] reintroduced into the economy [by lending]." Though it leaves things out, it conveys an idea that is partially true. My problem with the perpetual motion thing is that this "reintroduced" money increases financial cost. This financial cost is something that the defenders of perpetual motion always manage to overlook, which is why financial crisis always catches them by surprise.

Art

ps, I would not define credit excesses as "credit displacing the lack of income gains". That was a late-stage phenomenon. Credit use becomes excessive, not when it creates a great recession, but the first time it becomes a drag on economic growth.