PrintHow many times have you heard that the key to reviving the economy is fixing the banks? The thinking usually goes: If the banks are fixed--if bad loans are taken are taken off the books, and if regulations are put in place to prevent risky new loans--then they will resume lending to consumers who will buy cars and homes, and to businesses that will invest in plants and hire new workers. That's probably why Washington has spent the last six months proposing bank reforms, but not worrying about whether the first stimulus adopted is going to be sufficient. In my opinion, that's a mistake. There is a banking crisis, but much of the solution to it lies elsewhere--namely, with more government spending.
Last fall, the Treasury and the Federal Reserve had to do something about the banks to prevent the collapse of the economy. At that time, banks were unwilling to lend to one another, let alone to individuals and businesses. Federal guarantees against failure and an infusion of reserves prevented the system's collapse. There are clearly more things to be done to prevent a future panic, such as consolidating and strengthening financial regulation, but these kind of measures don't necessarily bear on what's important to revive today's economy.
The real problem is that borrowing is down. According to the Fed, during the first quarter of 2009, private borrowing by households declined by 1.1 percent and by nonfinancial businesses by 0.3 percent. Net borrowing--the funds borrowed minus those repaid--was down $151.8 billion for households and $28.3 billion for businesses. If individuals are spending part of their earnings paying off credit-card debts or student loans rather than buying a home or car on credit, and if businesses are using their profits to pay off debts rather than to invest, then the economy is going to shrink. The question is what accounts for this decline in borrowing.
The usual answer is that the banks don't have the money to loan, or the capital to absorb losses on existing or new loans. But much of the money they loan is not from deposits (which, incidentally, have been rising), or from interest made on loans, but rather money they themselves have borrowed at lower interest rates than they plan to charge. With federal interest rates near zero, banks are able to borrow money cheaply and lend it to individuals and businesses at very attractive rates. Even with old loans weighing them down, the banks' risk of losing money on new loans has been substantially reduced.
Could the problem, then, be with the borrowers rather than the lenders? That's the answer given by Richard C. Koo, the chief economist of the Tokyo-based consulting firm Nomura Research Institute, in a new book, The Holy Grail of Macro-Economics: Lessons from Japan's Great Recession. Koo argues that the Great Depression of the 1930s, Japan's 15-year recession beginning in the 1990s, and our current downturn are examples of "balance-sheet recessions."
During balance-sheet recessions, individuals are reluctant to spend, and businesses are more worried about paying down their debts than maximizing their profits, wary of expanding their output at a time when there's little demand for their products. So individuals save money and businesses stop borrowing it even when interest rates, which normally spur such activity, approach zero. And this is pretty much what happened in the 1930s and more recently in Japan.
During the Great Depression, Franklin Roosevelt's initial reforms stemmed the financial crisis, but they by no means revived the overall economy. The private debt of non-financial businesses and individuals fell from $129.6 billion in 1929 to $100.6 billion in 1939. The reason that the rate of unemployment fell at all during this period and that economic growth picked up was because the increase in public debt--from $20 billion in 1930 to $108.7 billion in 1939--compensated for the decline in private lending.
Koo shows that during the Great Depression and Japan's recession, banks were willing to lend money, but borrowers couldn't be found. Koo cites the surveys that Bank of Japan conducted. These surveys, published in the Short-term Economic Survey of Principal Enterprises in Japan, showed that, except from 1997 to 1998 and from 2002 to 2003, "banks were willing lenders," Koo writes. He reasons, too, that if Japanese banks had been unwilling to make loans, and if businesses had still wanted to borrow, businesses would have raised money through foreign banks or through bond issues. Nothing like that occurred during Japan's recession.
Koo suggests that the same thing might be happening today. His book was finished early in 2008, so it doesn't taken into account the last six months, but there's evidence from the Fed that businesses are now unwilling to borrow. The Fed's most recent survey of bank loan officers, released in May, reports a decline in the number of banks tightening their loan terms over the last few months. At the same time, it reports "a further weakening of demand for C&I [commercial and industrial] loans from firms of all sizes over the previous three months.
As the Fed report makes clear, some banks have tightened their loan terms, but that is not necessarily because of worries about bad loans on the bank's books. They could be demanding risk premiums because of "a less favorable or more uncertain economic outlook," which affects their view of whether businesses or individuals will be able to repay the loans they make. But that doesn't detract from the central point in Koo's analysis: The basic problem does not lie inside the banks themselves, but with the businesses, consumers, and broader economy.
Equally, there may be differences between Japan's recession and the current recession. In Japan, households were notorious savers; it was businesses that accumulated the most debt. In the United States, households virtually stopped saving in the last decade--in 2008, the savings rate was zero. And the greatest concentration of debt was among households rather than businesses. The problem for American businesses may not be so much clearing their balance sheet as discovering sufficient demand among consumers and other businesses for their products to justify new investments. That, too, doesn't detract from Koo's central point about where the problem lies, but it casts it in a more conventional Keynesian mold.
Koo thinks the solution is to use government borrowing to make up for the slack in private borrowing until individuals and businesses clear their balance sheets. At that time, individuals will be ready to spend, and businesses to invest. (The more conventional Keynesian version, which may be more applicable to the United States now, is that government borrowing, by making up for the slack in private borrowing, will provide the demand necessary to inspire economic growth.)
How does government borrowing help clear balance sheets and create demand? The government borrows from Americans and foreigners, from individuals, businesses, and central banks, when its spending exceeds its revenue. It eventually has to repay those loans, but while it has that money, it can be used to stimulate demand. And as Koo notes, borrowing is much more effective when it is used to increase spending rather than to reduce taxes, since consumers and businesses can simply choose to save rather than spend their tax cuts.
Koo's analysis helps to explain something that's always puzzled me. In the early '90s, Japan suffered a massive decline in its assets very similar to that which the United States has suffered. Commercial real-estate prices declined by 87 percent and overall growth faltered--businesses and banks teetered on the edge of bankruptcy, and unemployment rose. The country was suffering from a recession, yet unemployment never reached 6 percent (ours is currently at over 9 percent), and GDP continued to grow, albeit at a slower pace.
Koo says the reason Japan's unemployment didn't rise further was because of the enormous public deficits it incurred. When it cut back on government spending in 1997 (similar to what the Roosevelt administration did in 1937 and what some Republicans advocate today), the economy suffered. Private borrowing finally resumed in 2005--not because of bank reform but because individuals and firms, having cleared their balance sheets, began borrowing and spending again. (This sounds right, although I would wonder, too, whether a boost from export demand in China and the United States also played a role.)
If Koo is correct, then the most important thing that the White House and Congress can do to solve the banking crisis is the same thing it can do to get the country out of the recession: counter the decline in private borrowing with a huge increase in public borrowing. That is, the government should borrow through bonds so that it can spend more than it takes in. The Obama administration started to do that this year. While household and business borrowing was negative for the first quarter of 2009, federal government borrowing increased 22.6 percent and state local government 4.9 percent. But this may not be enough to get the economy out of its doldrums. In an article in International Economy last fall, Koo called for a "seamless" three-to-five year stimulus program. That would go beyond the two year stimulus program that Congress enacted, and would also be unencumbered by tax cuts rather than spending increases.
If the Obama administration wants to solve the banking crisis, it may have to spend its political capital on a second stimulus program rather than on bank reform. The last thing it should do is listen to the deficit hawks squawking about rising government debt. The only way the government will ever be in a position to repay its debt is by getting the economy growing again.
COMMENTS (10)
Duh. Banks ain't lendin'. Folks ain't spendin'. No change in sight, either, because Americans are not nearly as wealthy as we thought. We have a national myth acc to which just about every literate, suburban adult with a pulse is middle class, and entitled to the economic security and fat happy consumerist binges that define bourgeois life. In reality, most of these people are merely uneducated proles with credit cards. Pay-the-piper time.
Duh. Banks ain't lendin'. Folks ain't spendin'. No change in sight, either, because Americans are not nearly as wealthy as we thought. We have a national myth acc to which just about every literate, suburban adult with a pulse is middle class, and entitled to the economic security and fat happy consumerist binges that define bourgeois life. In reality, most of these people are merely uneducated proles with credit cards. Pay-the-piper time.
"There are clearly more things to be done to prevent a future panic, such as consolidating and strengthening financial regulation, but these kind of measures don't necessarily bear on what's important to revive today's economy."
Very true.
There are two sides to the financial system problem: the lender and the borrower. Both are in over their heads with leverage, which is historically normal at the end of a credit supercycle
The degree of leverage by the financial system and the borrowers (currently probably a historical record) means all deficit spending should be focused on stabilizing the financial system, and supporting the economy in a way that allows repayment of debt. In addition t ... view full comment
"There are clearly more things to be done to prevent a future panic, such as consolidating and strengthening financial regulation, but these kind of measures don't necessarily bear on what's important to revive today's economy."
Very true.
There are two sides to the financial system problem: the lender and the borrower. Both are in over their heads with leverage, which is historically normal at the end of a credit supercycle
The degree of leverage by the financial system and the borrowers (currently probably a historical record) means all deficit spending should be focused on stabilizing the financial system, and supporting the economy in a way that allows repayment of debt. In addition to direct support of the banking system, Most of the $787 billion stimulus bill should have been a broad-based tax cut (including tax rebates) considering that the consumer is the single most important source of demand: about 70% of the demand for the American economy.
If the private economy is still overextended and struggling with debt load after all this public sector spending --- big government spending stimulus will fail as economic policy, which I consider to be quite likely because it doesn't address the financial dysfunction (Japanese experience). And then of course, the big government political class will call for even more ineffective big government spending. This is how the US could experience its "lost decade."
Worse yet --- not only did the big government political class fail in relieving the balance sheet load of the private sector locomotive, but is proposing to add additional freight in the form of energy regulation and taxes: huge uncertainties of large public sector interference in the automotive industry, finance, and healthcare. This has all the equivalency of FDR raising taxes in 1937.
The first argument for economic conservatives; the private sector should be allowed to keep its own earnings to pay down debt rather than a $787 billion "stimulus" program that is little more than a payoff to the constituencies of the big government political class: an execrable waste of stimulus money.
Second point: a large but temporary reduction in payroll taxes and rebates would eventually expire --- something we could certainly depend upon. Big government public sector stimulus spending will be extremely difficult, if not impossible, to stop its transformation into a permanent enlargement of government.
The third point for such a program; to the degree that demand-side tax cuts and rebates is used to pay down debt means that the increase of public debt is offset by decreased in private debt: thus no net increase of debt for the American economy, unlike public sector spending.
And the final point, to the degree that debt is paid down, the inverted pyramid of money supply from fractional reserve banking shrinks: the reverse of increased money supply through credit expansion (money multiplication by fractional reserve banking practice). This reduces money supply, offsetting the increase of base money supply from loose fiscal policy when the Federal Reserve creates money to finance the deficit. This reduces the threat of inflation from excess money supply, unlike public sector spending.
We need conservative leadership of Reaganesque optimism that America's best days are still ahead if we invest in the private economy through tax cuts rather than ineffective big government spending.
Does it ever occur to the left or politicians that people may be saving instead of spending becuase they watch the government assume unserviceable debt. Most productive people instinctively know that govt borrowing will crowd out private sector investment and that the productive population will be taxed heavily at some point.
I'm putting my money in the bank, no, perhaps burried in a safe in my back yard thank you very much.
Does it ever occur to the left or politicians that people may be saving instead of spending becuase they watch the government assume unserviceable debt. Most productive people instinctively know that govt borrowing will crowd out private sector investment and that the productive population will be taxed heavily at some point.
I'm putting my money in the bank, no, perhaps burried in a safe in my back yard thank you very much.
Curious, it seems that every analysis Mr. Judis spits out ends in one conclusion, "more government spending." What's the end game to the "increased government spending?" How much will finally be too much? 3 Trillion? 5? 10? Or is the underlying agenda a closer move to a state-controlled economy?
Curious, it seems that every analysis Mr. Judis spits out ends in one conclusion, "more government spending." What's the end game to the "increased government spending?" How much will finally be too much? 3 Trillion? 5? 10? Or is the underlying agenda a closer move to a state-controlled economy?
Ok, I bought $1,000 in bonds so the government can spend $1,000. A government contractor then gets that money after taxes. The contracter then uses the money to buy T-bills. The government's debt grows, the savings event still happens just like it would with tax cuts and the economy still doesn't grow because I and the contractor bought debt rather than pizza or a couch. Governement spending just won't accomplish more than tax cuts.
Also the government already runs deficits so why aren't those deficit's stimulating. Even the first prediction for 2009, before everything went sour, was the government was going to over spend by $400 billion this year. Do you even see that $400 billion doing ... view full comment
Ok, I bought $1,000 in bonds so the government can spend $1,000. A government contractor then gets that money after taxes. The contracter then uses the money to buy T-bills. The government's debt grows, the savings event still happens just like it would with tax cuts and the economy still doesn't grow because I and the contractor bought debt rather than pizza or a couch. Governement spending just won't accomplish more than tax cuts.
Also the government already runs deficits so why aren't those deficit's stimulating. Even the first prediction for 2009, before everything went sour, was the government was going to over spend by $400 billion this year. Do you even see that $400 billion doing anything for the economy? Nope.
If the government wants to encourage spending, it should offer 10 year 0% loans up to an x amount of money, let's say $2,500 a person. That's $800 billion in loans, smaller than the current stimlus package. Now have the $2,500 directed in the form of a coupon system (paper or electric) so people would have to buy stuff in order to claim the loan. This would be different than giving out cash, because the loans would mostly be paid back. It would be different than a tax credit because the money would have to be spent rather than saved. It would be different than government spending because there won't be a saver (the bond buyer) and a spender (the government), but everyone would be a spender and the deficit would be temporary rather than add to the national debt.
Not to say that I disagree Mr. Judis, though I'll admit I'm mightily skeptical. But at what point and under the leadership of what politician will the country be expected to tighten its belt and pay back these truely massive national debts that you are proposing? George W.'s answer to this question was "Don't know, someone after me. Pass that buck." I'd like to think we Democrats and our Hope and Change president will have a better answer.
Not to say that I disagree Mr. Judis, though I'll admit I'm mightily skeptical. But at what point and under the leadership of what politician will the country be expected to tighten its belt and pay back these truely massive national debts that you are proposing? George W.'s answer to this question was "Don't know, someone after me. Pass that buck." I'd like to think we Democrats and our Hope and Change president will have a better answer.
Two conceits of economists:
First, that an economy is some sort hydraulic steam engine, where heat or pressure from one source (e.g. consumer spending) can be replaced by heat or pressure from somewhere else (e.g. government spending) with predictable effects.
Second, that the experience of one society in one situation (say, Japan in the 90's) can be reduced to a few simple variables (spending, savings, etc.) and straightforwardly extrapolated to a very different society in a very different situation (the U.S. today).
I wish economists would be less like physicists and more like physicians: first do no harm.
Two conceits of economists:
First, that an economy is some sort hydraulic steam engine, where heat or pressure from one source (e.g. consumer spending) can be replaced by heat or pressure from somewhere else (e.g. government spending) with predictable effects.
Second, that the experience of one society in one situation (say, Japan in the 90's) can be reduced to a few simple variables (spending, savings, etc.) and straightforwardly extrapolated to a very different society in a very different situation (the U.S. today).
I wish economists would be less like physicists and more like physicians: first do no harm.
I am reading the comments above about spending and the concern with the national debt. Two thoughts come to mind: 1) How do tax cuts not qualify as spending and not increase the deficit? If supply side economics has any validity, then the country should not be in this mess due to the hugh supply side tax cuts, but all the right says is more tax cuts will create jobs--demand is irrelevant. 2) If we had cut spending to avoid massive deficits during WW2, then we would have called the troops home in 1943 when the deficits were approaching current levels. So lets do the right thing with spending--disband the standing army and shut down the military-industrial complex. Wait--that will cost jobs an ... view full comment
I am reading the comments above about spending and the concern with the national debt. Two thoughts come to mind: 1) How do tax cuts not qualify as spending and not increase the deficit? If supply side economics has any validity, then the country should not be in this mess due to the hugh supply side tax cuts, but all the right says is more tax cuts will create jobs--demand is irrelevant. 2) If we had cut spending to avoid massive deficits during WW2, then we would have called the troops home in 1943 when the deficits were approaching current levels. So lets do the right thing with spending--disband the standing army and shut down the military-industrial complex. Wait--that will cost jobs and it wouldn't even balance the budget! It would be useful if any of these deficit hawks would actually lay out the necessary spending cuts to solve the problem without destroying the economy.
My main concern lies with consumption. Is it really possible that our society consume more that we already do? Through the debt burden that's been assumed in both the public and private sectors, it's clear to me that were - and still are - on an unsustainable consumptive path. At what point do we wake up to the reality that a larger home a third automobile may not be in our future. I find it wholly disturbing that, for a fair number of people, the pursuit of higher education is used as a means to become a greater consumer of goods. I wonder if, in the future, the American identity will less bound to such ideals? I hope so.
My main concern lies with consumption. Is it really possible that our society consume more that we already do? Through the debt burden that's been assumed in both the public and private sectors, it's clear to me that were - and still are - on an unsustainable consumptive path. At what point do we wake up to the reality that a larger home a third automobile may not be in our future. I find it wholly disturbing that, for a fair number of people, the pursuit of higher education is used as a means to become a greater consumer of goods. I wonder if, in the future, the American identity will less bound to such ideals? I hope so.
In time all of you will come to realize that not regulating the financial world, the SEC, the CFTC, and the FED all had the powers but didn't use them and created this crisis. Then throwing money at the problem like Bernanke, Paulson & Geithner have been doing makes it worse. Naturally stopping the problem before it got a head of steam would have been nice, but Clinton & Greenspan got a stalled economy going in '95 or '96 and didn't listen to folks like Brooksley who saw a monster being created in unregulated derivatives and stock market excess investment. Which should have triggered massive tax increases (very progressive in formulation>)
Tax cuts & foreign adventureism ex ... view full comment
In time all of you will come to realize that not regulating the financial world, the SEC, the CFTC, and the FED all had the powers but didn't use them and created this crisis. Then throwing money at the problem like Bernanke, Paulson & Geithner have been doing makes it worse. Naturally stopping the problem before it got a head of steam would have been nice, but Clinton & Greenspan got a stalled economy going in '95 or '96 and didn't listen to folks like Brooksley who saw a monster being created in unregulated derivatives and stock market excess investment. Which should have triggered massive tax increases (very progressive in formulation>)
Tax cuts & foreign adventureism expenditures are deficit spending when it's borrowed from abroad.
Right now we need to tax everyone in this country and spend only on support of our own people to keep them fed, housed, and pass HR676 or the likes to eliminate this stupid health care disaster that helps no one and costs everyone. Lets just eliminate most military spending and spend about as much on green infastructure especially mass transit and energy efficient housing which leaves no one homeless. All government spending ( tax cuts and unnecessary political pork )that doesn't level the economic playing field compromises everyone's well-being and our countries economic future!
Thanks to the "conservatives" we now have a national debt about equal to 80% of our former massive GDP.
We are being daily threatened by our creditors and still these nuts call for tax cuts and more bank and corporate bailouts! A country is not too different from your own family budget! When you borrow more than you can pay off in a reasonable time given normal income expectations, you will bankrupt.
The mighty USA is on the verge of that right now!