Credit where credit’s due
The traditional school of economics that guides policy makers and permeates our underlying principles and culture is that referred to as the Neoclassical school.
As an arch priest of this school the likes of Ben Bernanke deny that credit is anything but a transfer of holdings between one party and another, and therefore is irrelevant to their models of the world.
This is despite overwhelming evidence from an academic who writing in 2009 demonstrated that those economists who did foresee the crisis all acknowledged the role of credit. He identified four common elements:
1) a concern with financial assets as distinct from real-sector assets,
2) with the credit flows that finance both forms of wealth,
3) with the debt growth accompanying growth in financial wealth, and
4) with the accounting relation between the financial and real economy.
On the one side were the hard money Austrian school proponents (such as Peter Schiff etc.) and on the other we had the likes of Steve Keen and others who embraced the Minsky Instability Hypothesis (such as Peter Warburton).
The reason that these people were able to foresee the problem building up is because they all recognise the fact that money used in day-to-day exchanges can in fact get separated from reality. Excessive credit, brought about by over-optimistic expectations of future growth is by far the most plausible explanation of why the cycles occur.
Which is why a recent speech by Andrew Haldane of the BoE is quite remarkable in its tentative recognition of the role of credit expansion in fuelling sub-optimal lending practices.
Mr Haldane has a noteworthy history of hard hitting publications. But, two things still worry me. Firstly is whether his proposals will ever make the light of day in terms of real policy change within the BoE.
And secondly is that it may be too little, too late. For the pyramid of credit has grown excessively high, whilst most of the modern world appears content to carry on worshipping at its feet.
UPDATE: January 24, 2011
Mish Shedlock has weighed in to the World Economic Forum’s recent publication endorsing further credit expansion for the globe:
Building on the critique by Steve Keen, Mish lists 18 flaws in the report which make it a damning indictment of modern economic thought.