George Osborne is showing commendable signs of starting to think about macroeconomics. However, I have several problems with his recent speech. He says:
The new economic challenge of our time, then, is to tame the credit cycle without damaging the dynamic financial sector.
And he suggests we consider using counter-cyclical capital requirements upon banks to limit their lending in good times:
financial crises are born during the financial booms that precede them - the only way to prevent the bad times is to stop the good times getting out of control.
I’ve got five issues here.
1. Is the “credit cycle” due more to supply forces - banks are readier to end in good times - or demand forces, with banks merely passively responding to changes in consumer and business confidence?
The question matters, because fluctuations in confidence can be justified. Imagine a technical breakthrough raises likely future productivity growth. It would be entirely rational for companies and consumers to borrow more in rational anticipation of better times. If you impose tougher capital controls in these conditions, you’ll just destroy sustainable and efficient economic activity.
2. Are counter-cyclical capital requirements feasible? Do governments really want to anger voters by denying them credit? And do they want to say: “the current good times aren’t the result of our good macroeconomic management - they are just a bubble”?
And even if one government does impose them, they’d be useless in just one country, as lending would merely shift offshore.
3. Is borrowing really unsustainable? Osborne says:
We have warned for several years that the boom in household indebtedness was unsustainable - as I said two years ago "an economy built on debt is living on borrowed time."
But is there a problem here? Put yourself in my position. In a couple of week’s time, my credit card bills will look horrible, as I’m buying a car and lots of furniture for my Oakham abode. And because I’ll not (I hope) repeat these purchases, my spending will crash later. In this sense, my debt and spending are unsustainable. But this is no problem, as I’ve got cash in the bank to pay these debts.
And the aggregate consumer is in a similar position to me. Households’ bank deposits are equivalent to over 12 months’ disposable income, and are six times as high as their non-mortgage debt (table A4.1 here). And individual insolvencies have fallen recently, suggesting over-indebtedness isn’t a serious aggregate problem.
The notion that households in general recklessly over-borrow in good times - a notion Osborne comes too close to supporting - owes more to a prejudiced contempt for individuals’ rationality than to the data.
4. Are asset price “bubbles” really destabilizing? The remarkable thing about the bursting of the tech bubble in 2000-01 was how little impact it had - it caused only the mildest recession in the US, and none at all in the UK.
Even the allegedly gloomy IMF believes the same could be true of the current credit crunch. It expects the global economy to grow by 3.7% this year. And even its forecast for the UK, of 1.6% growth, is only around a percentage point below our trend growth rate. This is hardly a catastrophe. And it might be too pessimistic. Latest data show that manufacturing and retail sales were stronger than expected in February, suggesting the economy is starting 2008 from a stronger base than thought.
This shouldn't be surprising. House prices are not net wealth, so a fall in them shouldn't greatly depress activity.
5. Is Osborne - like Brown and Darling - guilty of statistical fetishism here? What matters is not the volatility of GDP - which is small, even if the gloomiest forecasts are right - but the uncertainty faced by real individuals. People matter; statistical aggregates don’t. The task for a Chancellor, surely, should be to find ways of protecting people from risks they cannot control without overly reducing incentives. This is not so much a task for macroeconomic policy - even stable GDP growth can be consistent with massive insecurity for real individuals - as for the microeconomics of designing a welfare state or private insurance markets.