Just lend and be done with it
Increased lending is necessary because matters like credit allocation as well as restructuring of firms and economic activities after a period of misallocations are irrelevant to business cycles.
Recently, there have been reports in the Wall Street Journal and the Financial Times that Ben Bernanke and others are concerned that banks have not been lending “enough” to small businesses. The accusation is that lending standards are too strict.
“I keep hearing remarks that credit standards have tightened, and I don’t believe that… I need to make loans to survive, to make money.”
So what happened? The WSJ reports:
“Some lenders argued that current lending standards are a return to more-normal conditions following a period of laxity.”
1. We have just come out of a period when real interest rates were held at very low levels. This sparked a boom and excessive risk taking.
2. Many firms and activities over-expanded during the boom period. We cannot expect them to return to the status-quo ante.
3. Small firms were among the riskier activities.
4. Small firms are still among the riskier borrowers.
I believe that Bernanke and friends would reply. Yes, there are real risks out there but the reluctance to lend is self-fulfilling. This reduces aggregate demand and makes it harder for (small) firms to survive.
So Bernanke has no “macroeconomic knowledge problem.” He knows that we would all be better off if there were more lending because matters like credit allocation as well as restructuring of firms and economic activities after a period of misallocations are irrelevant to business cycles. Feed the Aggregate Demand God and all will be better. He better have that view or else the feasibility of macroeconomic management might be thrown into doubt. It gets – shall we say – complicated.
Finally, let me end on a relevant quotation from Frank Knight’s 1936 review of Keynes’ General Theory:
The … inference drawn by Mr. Keynes, and labelled “much more fundamental”, repeats a statement already quoted, along the same general line. It is that since “the extent of effective saving is necessarily determined by the scale of investment and [since] the scale of investment is promoted by a low rate of interest” (up to full employment), “it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment” (GT, pp. 374-5).
Passing over the fact that there is no way of knowing at all accurately when there is full employment, meaning no “involuntary” or “frictional” unemployment, there are two notable omissions.
Again, nothing is said either as to the consequences, monetary and other, of having a central bank unremittingly pumping money into the system by an arbitrarily low interest rate, or as to the political status of the official or board by whom it would be done. It surely re-quires an optimist to believe that it would or could be done without resulting in an unbalanced capital structure in industry, and more of an optimist to believe that the resulting situation could be cured — as Mr. Keynes must imply — by a further overdose of the same medicine which would have brought it about.
From: “Unemployment: And Mr. Keynes’s Revolution in Economic Theory ” Author: F. H. Knight Source: The Canadian Journal of Economics and Political Science / Revue canadienne d’Economique et de Science politique, Vol. 3, No. 1 (Feb., 1937), pp. 100-123. Quotation above at p. 119. Published by: Blackwell Publishing on behalf of Canadian Economics Association.
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