The dynamics of credit and debt shape macroeconomic outcomes. We lived through the largest credit boom in modern history. This created unprecedented levels of private debt in Western economies, followed by the sharpest credit contraction in over 80 years, with prolonged recessions in many countries. Time to rethink the role of credit and debt in our economies. But credit and debt were long neglected in economics. Banks, bonds, money and debt dropped out of macroeconomic models. Seminal contributions by Schumpeter, Keynes and Minsky remained marginal in academia. Monetary policy was reduced to inflation targeting. Asset markets were viewed as a sideshow to the economy’s fundamentals.
This left us badly equipped to answer fundamental questions. Is the business cycle a credit cycle? When is credit good for economic growth? Does credit growth increase the debt burden? Is the financial sector too large? What do banks do? How can bank reform make a difference? When does money growth lead to inflation? What does quantitative easing ease? Is public debt more harmful than private debt? How can international capital flows be helpful, and when are they harmful?
We need new research building on old foundations. We need to connect policy questions and academic work. We need academic space to discuss these questions. We need to bring together new thinking so that we can find new answers. We need an economics which takes credit and debt seriously.
This web site reports on my efforts to achieve this and links to related research.
What my research is about
Assessments of the role of the financial sector in the economy have varied from euphoric in the 1990s to gloomy post-2007. Until the 2007 crisis the scientific consensus was that the impact of financial-sector expansion on income growth is unambiguously positive. But since then, researchers increasingly find that financial-sector growth is associated with less investment, innovation and income growth - not just after a crisis, but in general, across many countries and years. This has sparked an intense debate in economic journals, policy reports by leading institutions and the media, in which I participated. Have we misunderstood the role of banks in the economy?
The issue is urgent, since other findings on inequality and financial fragility send the same message. Theoretical models suggest that the impact of financial-sector expansion should lead to a more equal distribution of incomes. However, since the crisis, there is evidence that growth of the financial sector is linked to more inequality. Likewise, the erstwhile consensus that the growth in the volume and range of financial assets and instruments stabilizes the economy – by providing opportunities to diversify risk and smooth consumption – is crumbling. Empirical research indicates that economies with larger financial sectors appear more prone to financial fragility and outright crisis8 – again, not just after 2007 but all along over the last few decades. But the conditions for this to occur remain unclear.
This scientific challenge is also one of large societal relevance. Never before did the financial sector expand so much faster than the economy, for so long, as in the last few decades – globally, and especially in Western economies. And it was just in these decades that income inequality and the incidence of financial crises both rose strongly, and growth dynamics changed markedly in most Western economies - with an unusually long period of stable real growth from the mid-1980s (the ‘Great Moderation’)10 then an unusually severe ‘Great Recession’ after 2007, and continuing financial fragility until today.
Taken together, this raises the question: When does finance help, hinder or hurt the economy in terms of stable income growth, inequality of incomes, and financial fragility?
With my research team, I engage in research, teaching, policy advice and media advocacy to harness finance for stable and equitable growth. We built a data set of bank credit flows covering 70 countries and going back to the 1970s (but with most data since the 1990s). Check out the Graphs section for an impression.
We undertake a broad range of analyses to understanding how banks may help, hinder and hurt the economy. These center on what I call “debt shift”: the shift in debt allocation by banks, away from supporting future production and incomes and towards financing capital gains in real estate and financial asset markets. For instance, in a balanced panel of 14 countries from 1990 to 2011, total bank debt rose strongly, mainly due to mortgage debt growth from 21% to 51% of the Gross Domestic Product on average (see this graph on p 6)
With my research team, I have been producing empirical evidence on the concurrence of debt shift with financial-sector expansion and with:
• slowing income growth
• rising financial fragility and
• rising income inequality,
... across many economies. But how are these outcomes connected to debt shift? The aims of our research program are to undertake and publish empirical analysis on the determinants and consequences of debt shift, and alongside this, to develop a theory of the causes and consequences of debt shift.
Debt shift, which has been a long-term process since the 1980s, defines how banks help, hinder and hurt the economy now and into the foreseeable future. Our aim is to identify and understand this trend, and to support with our research policies to curb it.