Tuesday, May 8, 2012

Why Credit Doesn’t Rise Forever? – The Limits of the Physical Economy

In recent years their has been a revival of the Credit theory of the business cycle. Pre-war it almost became mainstream – especially amongst Hawtry and his followers, such as those around the ‘old’ Chicago School such as Lauchlin Currie. Put very crudely growth is fulled by a net growth in credit and recession by its net contraction. When recession triggers negative balance sheets as opposed to just lower profits we have the worse condition of debt deflation and what today we call balance sheet recessions.

Recently these ideas have been revived and updated, via the ideas of Minsky – influencing figures such as Koo, Werner, Keen, Hudson and so on – and it seemed to fit perfectly the boom and bust before and after 2007.

But there is a problem if this is incorrectly treated as a ‘pure’ monetary theory of the business cycle. Why cannot debt keep growing upwards forever? – after all if growth in debt fuels aggregate demand (the modern idea of credit impulse/accelerator - though an earlier non mathematical version of it was set out by Hawtry) then it can in theory grow exponentially to the sky even with Minskyian ‘ponzi’ investors; so what triggers the inability to service debt and/or a fall in profits?

The problem of course is we dont live in a purely monetary economy, the matching side of the monetary circuit is the circuit in sales and production of goods and services, the real economy. Read More