Stiglitz on credit creation by banks

For those who think that Joseph Stiglitz doesn't know that banks actually create credit:

"We are not in a corn economy where banks serve as an intermediary between farmers who have excess seed and farmers who want more seed. We are in an economy where banks actually create credit. And that makes a very big difference."

h/t: wonkmonk

Does the concentration of finance matter?

It may sound like a strange question in light of all the talk about "too big to fail" during the last few years. But, believe or not, the idea that bank concentration has an impact on real economic activity isn't the standard view. Here's from a recent blog post by NY Fed economists Mary Amiti and David Weinstein:

The notion that financial institutions are large relative to the size of economies is not something that plays a prominent role in traditional economic theory. Macroeconomic textbooks tend to treat economies as composed of representative firms that are infinitesimal in size compared to any given market. As a result, positive and negative idiosyncratic shocks [movement in bank loan supply net of borrower characteristics and general credit conditions] to financial institutions cancel out due to the law of large numbers. 

However, this representation stands in stark contrast with the reality of concentration in financial markets. A striking regularity is that a few banks account for a substantial share of an economy’s loans.

Starting from this basis, Amiti and Weinstein have examined Japanese aggregate bank lending data and other aggregates and were able to demonstrate the following: banks matter, bank concentration matters, bank lending matters. No small feat.

On the issue of bank concentration and aggregate lending, they found that

...if markets are dominated by a few financial institutions, cuts in lending due to some change in financial conditions in just a small number of banks have the potential to substantially affect aggregate lending. Moreover, if firms find it hard to find good substitutes for loans like issuing equity or debt, then it is possible for their investment rates to fall as well. 

As for their take on banks' impact on the real economy, the conclusion to their paper (on which their blog post in based) gives a good summary:

Our paper contributes to this literature by providing the first evidence that shocks to the supply of credit affect firm investment rates. We find that even after controlling for firm credit shocks, loan supply shocks are a significant determinant of firm-level investment of loan-dependent firms. This result is particularly surprising because our sample is comprised of listed companies that have, by definition, access to equity markets. Moreover, the fact that so much lending is intermediated through a few financial institutions means that idiosyncratic shocks hitting large financial institutions can move aggregate lending and investment. We show that about 40 percent of the movement in these variables can be attributed to these granular bank shocks. This means that the idiosyncratic fates of large financial institutions are an important determinant of investment and real economic activity.

And the implication for policy, according to Amiti and Weinstein, is significant. Here is the relevant excerpt of their blog post on this point:

...[P]olicymakers without detailed information on the major financial institutions are likely to have a difficult time understanding the causes of lending and investment fluctuations. A large portion of Japan’s aggregate economic fluctuations can be traced to the country’s banking problems. 

While many researchers have focused on the implications of banks being “too big to fail,” we show that even if large banks do not fail, granular bank shocks can have substantial impacts on aggregate investment. 

For example, reductions in bank capital at large financial institutions can cause investment declines by firms that would like to borrow, while recapitalization of the right institutions can stimulate investment. In sum, this study shows that what happens to large financial institutions is important for understanding aggregate investment behavior. 

While their paper looks specifically at Japanese data, the authors suggest that the overall conclusions are relevant to the situation in the US given that it too has a very concentrated banking sector.

Amiti, Mary and David Weinstein, How much do banks shocks affect investment: Evidence from matched bank-firm loan data, NY Fed staff paper 604, March 2013

Josef Steindl on why austerity fails: A Keynesian-Kaleckian view of stagnation policy and the endogenous budget deficit

This policy of stagnation is likely to continue, since governments are preoccupied with inflation and the public debt. Budget deficits can only disappear if private investment soars again. This is unlikely in view of excess capacity, which would only disappear if there were fiscal expansion. Josef Steindl (1979)

Surely the person who wrote the statement above would have no difficulty explaining what's wrong with the world economy today.

Josef Steindl was a great Keynesian-Kaleckian economist who was a master in the art of national accounts analysis. He was a close associate of Michal Kalecki and authored several articles on the important role of government and private debt in the economy. A quick glance at some of the titles of Steindl's work reveals that his articles on these issues might be of some relevance right now. (For more on Josef Steindl, see Nina Shapiro's excellent article published last year in Monthly Review)

Steindl's work was aimed primarily at uncovering the causes of economic stagnation. According to Steindl's "stagnation theory", one reason why economies trend toward stagnation is due to the behavior of firms when they refuse to reduce prices sufficiently relative to wages during periods of low demand. Low wages relative to prices lead to a fall in demand for goods and services, which in turn compels firms to reduce investment and creates a vicious cycle of falling profits and further cost reduction and reduced investment (resulting in additional unused capacity and unemployment and falling demand).

Steindl also argued that economies stagnate as a result of "stagnation policy", ill-advised government austerity measures intended to reduce or eliminate budget deficits when the economy is weak. Contrary to conventional wisdom, Steindl argued that austerity policies only make matters worse under such circumstances.

Steindl criticized austerity because he understood that the government's financial balance in the modern era was largely an endogenous variable that is determined primarily by changes in the financial position of other sectors of the economy, not by the autonomous policy decisions of the fiscal authorities. It is the influence of government automatic stabilizers and the growing importance of both consumer credit and foreign trade in the modern economy that render the government's financial balance largely endogenous.

The core of Steindl's approach to macroeconomic analysis is intuitive and similar to that of other Keynesian economists, including James Tobin (1963), Robert Eisner (1986) and Wynne Godley, all of whom analyzed the workings of the economy by examining how different sectors of the economy interact with one another. He divided the economy into four sectors (the government, households, businesses and the foreign sector) and examined how money flowed between them.

Steindl's analysis focused on credit flows and on how changes in one sector impacted other sectors. In doing so, Steindl basically applied an elementary principle of accounting to national economies: for every borrower there must be a lender. His method relied heavily on the use of national accounts data to identify trends and changes in financial flows. According to Steindl,

[t]he instrument for analysing the circular relations in an economy are the national accounts. They are a double entry book-keeping for the society, whole groups like households, business or government being represented by separate accounts, as are also activities like investment, consumption and so on. The systematic development of national accounting received its great impetus from Keynes and his theory [...] It offers a convenient way between the sterility of the Walrasian general equilibrium and the limited scope of the partial analysis of Marshall, because it is couched in terms of variables which are statistically measurable and at the same time relevant for national economic policy.(1985)

Steindl understood that, in terms of national accounts, the government deficit finds its counterpart in the surplus of at least one other sector of the economy. Since the surpluses and deficits of the various sectors (government, households, foreign and business) must balance, Steindl recognized that a huge deficit in one sector is always offset by surpluses elsewhere.

The endogenous budget deficit and the fallacy of austerity

Steindl was critical of the ("pre-Keynesian") tendency of many economists to view government budget deficits as an irritant to be eliminated. According to him, deficits in the modern era accomplished the opposite: they helped to boost aggregate demand when the economy is weak.

As mentioned above, Steindl viewed the budget deficit as a passive symptom of a weak economy rather than a problem to be actively addressed: actively trying to eliminating budget deficits would only worsen the situation. Steindl recognized that the size of the budget deficit is largely determined by the spending flows occurring among the other sectors of the economy. In this sense, he viewed the budget deficit largely as an endogenous variable that can't be easily controlled by policymakers. On whether the government has the ability to control the size of the budget deficit by changing its level of expenditures and/or revenue, Steindl argued the following:

While it is possible, in principle, to control the volume of government spending or taxation, the same is not true for the budget deficit. This is determined by the level of GDP resulting from the interplay of lending and borrowing of the various sectors. Let me refer to the well-known identity

( I – S_B) + (X – I) + (G – T) = (S_H – H)

Which says that the budget deficit G – T together with the borrowing of business I – S_B and of the outside world X – M equals the lending of households (i.e., excess of household saving S_H over investment in dwelling houses H) of households S_H – H.

Which of these sectors plays an active role depends on institutional circumstances. The budget deficit, in connection with Keynesian policies, used to be regarded as an active element, incurred on purpose by the government. In present circumstances it is more likely to play a passive role, and to be dominated by the other sectors. This is due to the large share of taxation in an additional GDP, to the strong and quick reactions of consumers to a change in income and to the fact that the foreign balance is more often dominated by outside influences than by domestic policy (by the GDP). In consequence attempts at reducing the budget deficit by retrenchment are mostly doomed to failure. [...]

If the foreign account is balanced, the budget deficit has simply to fill the gap between the household financial saving and the borrowing of business. This will apply to some approximation in countries where the role of the foreign balance is small as compared with that of other sectors. It will fully apply to all countries taken together because they form a closed system. For them the budget deficit given the financial surplus of the households, will be largely settled by the amount of private investment. On the other hand, in countries where the foreign balance can take large values it will, together with private investment, dominate the size (and sign) of the budget deficit. In both cases the budget deficit is predominantly suffered rather than contrived.

The conclusion is not pleasant to contemplate for the treasurer because it means that he can control the deficit, if at all, only by indirect routes: Business investment, and a fortiori the foreign balance, are not easy to control. (1983) (my emphasis)

That said, according to Steindl, there are circumstances in which the budget deficit can be made to decrease. Such favorable conditions are the same as those which lead to growth in private sector investment, namely, a satisfactory utilization of capacity and a growing market. In this regard, Steindl concludes that

[o]n certain conditions it would seem therefore that the best way to combat a deficit is to increase spending. The conditions are that there are unemployed resources, and that the additional spending is not drained away by imports. In these circumstances a policy of "reflation" should have a good chance of succeeding without adding to the budget deficit at all. On the one hand, the built-in stabilisers in modern welfare state are very strong. About half of the additional spending will come back to the treasury. On the other hand we have a modern destabiliser in the form of consumer's credit and durable goods consumption which will prevent the multiplier from being too low. This response of consumption will be very quick in contrast to the response of business investment which may take one or two years at least. In the interval business will merely accumulate additional saving. At the same time the consumers, owing to the expectation of a persistently higher level of income, will increase their spending on durables more than their disposable income has increased; they will therefore, taken all together, dissave (borrow) on balance, at the margin. (1983)

Now, it's important to point out that Steindl wrote the above at a time when growth in consumer credit could function as a way to counter the deflating effect of deficit reduction. Today, this is not the case, as consumers are seeking to repair their balance sheets following the financial crisis. This means that the only solution would be the one articulated in Steindl's quote found at the top of this post.

To conclude, there is growing appreciation these days among economists and commentators of the self-defeating nature of austerity and deficit reduction measures. The difficulties that many European nations are now facing in their quest to bring down deficits is consistent with Steindl's view that government austerity is exactly the wrong strategy for reducing the size of the budget deficit and bringing down debt during a period of slow growth.

PS: I recently stumbled upon this comment by economist Herbert Simon discussing Steindl's brand of economics:

It is pleasant, in an econometric world that has become idolatrous of mathematical "elegance," to encounter an author who thinks that mathematics is a tool - one of several - to aid in carrying out reasoning about economic matters.

References

Eisner, R., How Real is the Federal Budget? (New York: Free Press), 1986

Steindl, J., “The Role of Household Saving in the Modern Economy”, Banca Nazionale del Lavoro Quarterly Review, p.83, March, 1982

Steindl, J., "J.M. Keynes: Society and the Economist", Keynes' Relevance Today (London: MacMillan) 1985.

Steindl, Josef. “The Control of the Economy”, Banca Nazionale del Lavoro Quarterly Review, pp. 235-248, 1983

Shapiro, N., "Keynes, Steindl, and the Critique of Austerity Economics", Monthly Review, Vol 64, No.3, 2012

Simon, H., "Random Processes and the Growth of Firms: A Study of the Pareto Law" by Josef Steindl: Review, Journal of the American Statistical Association, Vol. 61, No. 316 (Dec., 1966), pp. 1232-1233

Tobin, J., Deficit, Deficit, Who's Got the Deficit, January 1963. New Republic, 1/19/63, Vol. 148 Issue 3, p10. 

The BIS's new long series on private non-financial credit

The Bank for International Settlements has introduced a new data series on total non-financial credit (loans and debt securities) covering 40 economies and spanning an average period of 45 years. The new series are intended to improve comparisons between different countries and across time. One interesting aspect of these new series is that they account for credit from all sources, not only that extended by domestic banks.

Here is a short article that gives a good overview of the new series. It contains several BIS signature-style charts and, for illustration purposes, provides a look at the evolution of total private non-financial credit worldwide:

While total credit has generally risen substantially relative to GDP, levels and trends in private sector borrowing have varied across countries to a surprising degree. For instance, in several economies, total credit-to-GDP ratios already significantly exceeded 100% in the 1960s and 1970s. Equally, in a number of countries, the share of domestic bank credit in total credit has actually increased substantially over the last 40 years – that is, banks have become more, not less, important. And finally, sectoral breakdowns show that there has been a general shift towards more household credit. In some countries, households now borrow even more than corporates.