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A presentation held by the Swedish Minister for Finance Anders Borg at Global Utmaning's and the Swedish House of Finance's seminar "Combating the Debt Addiction" at the Stockholm School of Economics, Thursday May 22, 2014.
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Combating Debt Addiction
Adair Turner
Senior Fellow, INET
The Swedish House of Finance Global Utmaning
22 May 2014
www.ineteconomics.org
300 Park Avenue South | New York, NY 10010
22 Park Street | London W1k 2JB
2
Escaping the Debt Addiction: Monetary and Macro-prudential Policy in the Post-crisis World. Center for Financial Studies, Frankfurt, 10 February 2014 http://ineteconomics.org/blog/institute/adair-turner-escaping-addiction-private-debt-essential-long-term-economic-stability
Credit, Money and Leverage: What Wicksell, Hayek and Fisher Knew and Modern Macro-economics Forgot. Stockholm School of Economics Conference “Towards a Sustainable Financial System", 12 September 2013, http://ineteconomics.org/blog/institute/adair-turner-credit-money-and-leverage
Wealth, Debt, Inequality and Low Interest Rates: Four big trends and some implications. Lecture at Cass Business School, London 26 March 2014http://ineteconomics.org/wealth-debt-inequality-and-low-interest-rates-four-big-trends-and-some-implications
Reference:
3
Private domestic credit as a % of GDP: Advanced economies 1950 – 2011
Source: Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten, C. Reinhart & K. Rogoff, 2013
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130
50
100
150
200
250
300
Source: International Monetary Fund; Bank for International Settlements
Private and public leverage: G7 + BRIC
6
China: total social finance to GDP
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013100
120
140
160
180
200
220
7
Dynamics of real GDP and credit(Year on year % change)
Source: Monthly Bulletin, European Central Bank, January 2014
Real GDPReal credit to householdsReal credit to NFCs
United States United Kingdom
8
The Dilemma
Pre-crisis path of nominal GDP growth
Pre-crisis path of credit growth
! 4% - 5%
! 10% - 15%
If central banks had raised interest rates to slow credit growth…. this would presumably mean slower nominal GDP growth?
We seem to need Ċ ˃ NGḊP to ensure adequate NGḊP… but this produces financial instability and post-crisis recession
@ 2% real growth
@ 2% inflation
9
The Dilemma
We seem to need credit growth faster than
GDP growth to achieve an optimally growing
economy, but that leads inevitably to crisis
and post-crisis recession.
10
Debt contracts: The finance theory perspective
Non-state contingent contracts overcome “costly state verification” advantages over equity contracts in business finance
Essential to mobilisation of capital
Empirical evidence of benefits of financial deepening, i.e. bank credit ÷ GDP
11
Pre-crisis orthodoxy: monetary policy
Low and stable inflation as sufficient for macroeconomic stability
- Implicitly Wicksellian(natural rate = money rate of interest)
The dominant new Keynesian model of monetary economics lacks an account of financial intermediation, so that money, credit and banks play no meaningful role
Mervyn King, ‘Twenty Years of Inflation Targeting’, The Stamp Memorial Lecture, 2012)
* * *
12
“A growing body of empirical analyses […] demonstrate a strong positive link between the functioning of the financial system and long-run economic growth […] better developed financing systems ease external financing constraints facing firms”
Ross Levine: Finance and Growth: Theory and Evidence. Handbook of Economic Growth, 2005
Positive correlation between growth and:
• Liabilities of financial system ÷ GDP
• Bank credit to private enterprise ÷ GDP
• Turnover of equity markets ÷ market capitalisation
Pre-crisis orthodoxy
13
The problems with debt
Cycles of over-supply and over-demand
‘Local thinking’Upswing
Downswing Bankruptcy and default
Rollover need and impaired lending capacity
Debt overhang
14
Textbook descriptions of banks and bank lending
Banks take deposits
of money from
savers and lend it to
borrowers
Banks lend money to ‘entrepreneurs/ businesses’, thus allocating funds between alternative investment projects
15
Banks create credit, money and purchasing power
Loan to entrepreneur
100 Credit to entrepreneurs deposit account
100
Bank
16
Three conceptually distinct functions of lending
Finance of new capital investment
• Enabling inter-temporal shift of consumption within life time income
Finance of purchase of existing assets
Finance of increased consumption
• Non-real estate• Commercial real estate• Residential real estate• Human capital
• Real estate• Collectibles• Existing business assets – e.g.
Leveraged Buy Outs
17
Categories of bank lending: UK, 2009
227
1235
243
232 Primarily productive investment
Some productive investment and some leveraged asset play
Mainly purchase of existing assets
Pure life-cycle consumption smoothing
Other corporate
Commercial real estate
Residential mortgage (including securitizations
and loan transfers)
Unsecured personal
£bn
But also achieves life-cycle consumption smoothing
18
The dominance of real estate in bank lending
Total bank credit to domestic
private sector% of GDP
Mortgage credit
% of GDPMortgage credit
as % of total
129% 74% 57%
206% 131% 64%
155% 78% 50%
175% 101% 57%
122% 78% 64%
130% 91% 70%
+ Commercial real estate at
typically around 20% - 25% of total
lending
Source: Jordá, Schularick and Taylor, “Betting the Home”, forthcoming 2014
(*Bank and non-bank combined)
*USA
AUS
ESP
NLD
SWE
DNK
19
Share of real estate lending in total bank lending
Source: The Great Mortgaging, Professor Alan Taylor, University of California, Davis
20
“With very few exceptions, the banks’ primary business
consisted of non- mortgage lending to companies in 1928
and 1970. By 2007 banks in most countries had turned
primarily into real estate lenders. The intermediation of
household savings for productive investment in the
business sector – the standard textbook role of the
financial sector – constitutes only a minor share of the
business of banking today.”
(Oscar Jordá, Moritz Schularick and Alan Taylor,
“The Great Mortgaging”, 2014)
21
Credit and asset price cycles: upswing
Expectation of future asset
price increases
Increased credit extended
Low credit losses: high bank profits• Confidence reinforced • Increased capital base
Increased asset prices
Increased lender supply of credit
Favourable assessments of
credit risk
Increased borrower
demand for credit
22
Credit and asset price cycles: downswing
Expectation of future asset price falls
Less credit extended
High credit losses: low bank profits• Confidence dented• Reduced capital base
Falling asset prices
Restricted lender supply of
credit
Cautious assessments of
credit risk
Reduced borrower
demand for credit
23
Credit extension and house prices
House prices 2000 – 2007 Household debt as a % of GDP 2000 – 2007
Source: BEA; ONS; ECB
0
20
40
60
80
100
120
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007%
G
DP
US UK Spain Ireland
0
50
100
150
200
250
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007
Ind
ex:
20
00
= 1
00
Spain US UK Ireland
Source: Ministry of Housing (Spain), S&P (US), DCLG
24
1700
1750
1810
1850
1880
1910
1920
1950
1970
1990
2010
0%
100%
200%
300%
400%
500%
600%
700%
800%Net foreign assetsOther domestic capitalHousingAgricultural land
Capital in Britain 1700 – 2010 %
nati
onal
inco
me
Source: Capital in the Twenty First Century, T. Piketty (2013)
Desirable urban land: a market without equilibrium?
25
Indeterminate price – is there
an equilibrium?
Potentially infinite supply of credit
and private money
Highly income elastic demand
Capital gains motivation
Expectations prices expectations
Inelastic supply of
locationally specific land
26
Average income increases US (1980=100)
0
50
100
150
200
250
300
350
bottom 20% top 5% top 1%
Sources: US Census Data, The World Top Incomes Database
Source: US Census Bureau; World Top Incomes Database
27
Inequality, demand and credit
Rich have higher marginal
propensity to save than poor
Rising inequality Deflationary
impetus – growth of NGDP falls
Rich lend to poor
Deflationary impetus offset:
• NGDP growth maintained
• Growth in credit intensity
Savings not matched by
investment
+
28
Dynamics of real GDP and credit(Year on year % change)
Source: Monthly Bulletin, European Central Bank, January 2014
Real GDPReal credit to householdsReal credit to NFCs
United States United Kingdom
Interactions between credit categories and effects
Increased apparent wealth
Reduced saving:
increased consumption
Increased price of
existing real estate
Increasing credit supply
/ demand
Equity withdrawal mortgage supply & demand
Boom in new real estate
construction
Increased prices for new real
estate
Borrower and lender net worth, confidence
and expectational effects
30
?
Two questions:
Why does this growth in leveraging matter?
How is it possible without stimulating inflation??
Sectoral financial surpluses/deficits as % of GDP: Japan 1990 – 2012
Source: IMF, Bank of Japan Flow of Funds Accounts
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
-15
-10
-5
0
5
10
PNFCs Government
%
31
Japanese government and corporate debt:1990 – 2010
Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations
% G
DP
0
50
100
150
200
250
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 20010
Bank lending to non-financial corporates General Government debt
34
Categories of credit creation and nominal demand
Stimulates nominal demandFinance of investment
Finance of consumption
Finance of existing asset purchase
Stimulates nominal demand offsetting impact of inequality
• No direct stimulus to nominal demand• Could just increase credit, money balances
and asset pricing• May stimulate demand via wealth effects and
Tobin’s Q effects• But not certainly proportional to credit
created
35
Bank lending to real estate sector and prices: Japan 1981 – 1999
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%Commercial Land Price in
the Six Major Cities (L)
Bank Lending to the Real Estate Sector (R)
YoY%
Source: Japan Real Estate Institute; Bank of Japan; Profit Research Center Ltd; calculations by Prof. Richard Werner, Southampton University (see Princes of the Yen, Richard Werner, 2003)
36
Credit creation for GDP transactions and nominal GDP in Japan, 1983 – 1999
Source: Princes of the Yen, Richard Werner, 2003
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
-4
-2
0
2
4
6
8
10
12
-4
-2
0
2
4
6
8
10
12
YoY %
Cr (L)
Nominal GDP
YoY %
Explaining instability and secular stagnation | 37
Quantity theory of disaggregated credit*
NOT
But:
So that:
And:
∆M = ∆P. ∆Y
∆CR = ∆PR
∆CNR = ∆P. ∆Y
∆M = ∆CR + ∆CNR ˂ ∆P. ∆Y
Velocity of circulation stable
… where CR = credit to finance real estate purchase+
PR = price of real estate
… CR = credit to finance GDP transactions P = prices of current goods and
services
Velocity of circulation falls
* See Richard Werner, New Paradigm in Macroeconomics
+ Or more generally to finance existing assets
38
Velocity of money circulation
Source: BoE, BoJ, Datastream
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Q4
1980
Q2
1982
Q4
1983
Q2
1985
Q4
1986
Q2
1988
Q4
1989
Q2
1991
Q4
1992
Q2
1994
Q4
1995
Q2
1997
Q4
1998
Q2
2000
Q4
2001
Q2
2003
Q4
2004
Q2
2006
Q4
2007
Q2
2009
Q4
2010
UK (M2) Japan (M2)
Velocity of Money (Nominal GDP/M4)
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Q4
1980
Q2
1982
Q4
1983
Q2
1985
Q4
1986
Q2
1988
Q4
1989
Q2
1991
Q4
1992
Q2
1994
Q4
1995
Q2
1997
Q4
1998
Q2
2000
Q4
2001
Q2
2003
Q4
2004
Q2
2006
Q4
2007
Q2
2009
Q4
2010
Japan (M4) UK (M4)
Velocity of Money (Nominal GDP/M2)
39
Not one objective, one instrument
Low and stable inflation insufficient
Credit and asset price cycle and rising leverage can produce macroeconomic instability while never producing excess inflation
• Interest rate elasticity of demand for credit varies by category
• Contrary to Wicksell, there is no one natural rate
Interest rate tool insufficient
40
Other policy objectives and tools
• Constrain both pace of growth and level of private sector leverage
• Offset bias in system toward real state lending
• Much higher bank capital requirements
• Much higher counter-cyclical capital requirements
• Increase capital risk weights for real estate lending above IRB levels
• Loan to income constraints on borrowers
• Banks with dedicated focus on non real estate
Objectives Tools