The Long-Term Drivers and Macroeconomic Implications of Credit Supply Expansion

This podcast episode delves into the long-term trends of credit growth, particularly since the 1980s, analyzing where credit originates and its macroeconomic effects. The speaker highlights the 'hockey stick' phenomenon of skyrocketing total credit to GDP across advanced economies, alongside a puzzling, significant decline in real interest rates. This co-movement of quantity and price suggests a fundamental expansion in the supply of credit, rather than demand. The core argument posits that this credit supply expansion is largely driven by rising income inequality, specifically the increasing share of income held by the top 1%, coupled with a substantial decline in top marginal tax rates. This shift in income distribution, given the non-homothetic savings preferences of high-income individuals, leads to a growing pool of 'surplus savings' that are channeled into the financial sector.

The analysis distinguishes this supply-driven view from traditional macro models where credit is primarily demand-driven (e.g., permanent income hypothesis or life cycle motives). It emphasizes that the increased credit is predominantly absorbed by household and government debt, not real investment, and disproportionately by the bottom 99% of the income distribution. In an open economy context, the concept of a 'global savings glut' is introduced, where excess savings can be exported or absorbed by government deficits, acting as substitutes for household borrowing. Empirical evidence, including cross-country and micro-level data, supports a strong correlation between rising inequality and increased household credit, suggesting a fundamental structural shift since the 1980s where global growth has become increasingly unequal.

The speaker further argues that this incremental credit is increasingly used to finance consumption, creating a 'credit-driven household demand channel,' rather than productive real investments. This deviation from traditional models is supported by business cycle facts: states or countries with larger credit booms tend to experience deeper recessions later. A natural experiment using 1980s bank deregulation demonstrates that credit expansions disproportionately boost the non-tradable sector (both in quantity and price), indicating that credit primarily moves aggregate demand rather than aggregate supply. This implies that credit booms, by driving demand, can lead to future slowdowns in GDP growth.

The long-term ramifications of this credit-driven growth are significant, especially as economies approach aggregate constraints. Two primary concerns are the zero lower bound on interest rates, which can lead to a 'liquidity trap' where further price adjustments are impossible, forcing the real economy to contract to absorb surplus savings. The second concern is that very low interest rates might reduce market competitiveness and slow growth, creating a backward-bending supply relationship. The speaker concludes that a more equitable growth process is essential to address these surplus savings, suggesting policy interventions like improved risk-sharing products and even wealth taxes as radical but potentially necessary tools to manage these structural imbalances and prevent future economic instability.

"where does credit actually come from and that's the question that I want to think about a little bit more carefully"

"the main card is what GST called the hockey stick fact that since the 80s total credit to GDP has basically skyrocketed"

"if you put the quantity and the price picture together collectively they are telling us that for some reason... it has been an expansion in the supply of credit"

"the basic fact about savings behavior that has been extremely well documented is that when you look at savings behavior preferences look non homo thetic"

"the growth in credit is connected with rising inequality is also consistent with who has been borrowing more than others"

"credit increasingly since the 1980s unlike our traditional textbook models it's not the increase the Mindil credit if you like has not is not being used to finance investments real investments but it's being used to finance consumption"

"stronger growth in household credit unconditionally predicts slowdown in GDP growth going forward"

"if this credit variable is really moving local demand more than local supply then it should primarily load up on the non-tradable sector both in terms of quantity as well as in terms of prices"

"as a macro economist everything I've said it's just fine the prices are you testing which is like the interest rate is adjusting and you know demand is now being funded differently but who cares the aggregate economy is still the same except that there is a problem"

"if it takes ever lower interest rates to convince people to borrow more and more what if you hit zero and now there is no more price adjustment we had then you hit what is called a liquidity trap"

"the most radical conclusion that comes out of this sort of analysis is it wealth tax might be useful"