Last week, the Prince posted the below chart showing the spectacular rise and then stagnation of private credit in Australia:
This rise in private credit, which is largely attributable to housing debt, has seen Australia become one of the most heavily mortgaged nations in the developed world (chart from the IMF):
Commentators like Professor Steve Keen have for years been warning that the excessive build-up of debt levels significantly increases the risk of financial instability and vulnerability to external shocks.
Now the Federal Reserve Bank of San Francisco (FRBSF) has published a detailed study, entitled When Credit Bites Back: Leverage, Business Cycles and Crises, which examines the role of leverage in the business cycle based on a survey of nearly 200 recession episodes in 14 advanced countries between 1870 and 2008.
Some of the key findings from the FRBSF paper are as follows (as summarised by Ben Rabidoux):
We document a new and, in our view, important stylized fact about the modern business cycle: the credit-intensity of the expansion phase is closely associated with the severity of the recession phase. In other words, we show that a stronger increase in financial leverage, measured by the rate of growth of bank credit over GDP in the boom, tends to lead to a deeper subsequent downturn. Or, as the title of the paper suggests|credit bites back.
…Higher leverage raises the vulnerability of economies to shocks. With more nominal debts outstanding, a procyclical behavior of prices can lead to greater debt-deflation pressures. Higher leverage can also lead to more pronounced con fidence shocks and expectational swings, as conjectured by Minsky. Financial accelerator e ffects described by Bernanke and Gertler (1990) are also likely to be stronger when balance sheets are larger and thus more vulnerable to weakening. Moreover, many of these e ffects are likely to be more pronounced when leverage explodes” in a systemic financial crisis.
It is heartening to see mainstream establishments like the Federal Reserve finally acknowledging and studying the theories of Hyman Minsky and his contemporary followers, and abandoning the ‘consenting adults’ view that debt doesn’t matter as long as it is held by the private sector.
I guess we are all Keensians now.
