In his testimony before the Congressional Committee on Financial Services the Chairman of the Federal Reserve Board, Alan Greenspan, said that he could see good chances for a sustainable expansion of the U.S. economy.
According to Greenspan:
The household sector’s financial condition is stronger, and the business sector has made substantial strides in bolstering balance sheets. Narrowing credit risk spreads and a considerable rally in equity prices have reduced financing costs and increased household wealth, which should provide substantial support for spending by businesses and households. With short-term real interest rates close to zero, monetary policy remains highly accommodative. And it appears that the impetus from fiscal policy will stay expansionary, on net, through this year.
In short, Greenspan has informed us that his low interest rate policy since January 2001 is finally starting to produce good results. But is it factually correct that the financial condition of consumers and businesses has improved to such an extent that economic expansion is likely to be sustainable? [MORE]
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In this criticism of Federal Reserve monetary policy, Frank Shostak asks the following question: “How in the world can credit, which is not backed-up by real savings, generate economic growth?” It is clear from Frank’s discussion that he believes that the answer to that question is unequivocally NO.
I assume that economic growth is an increase in real output (over some time period) or at least an increase in output per capita. By either measure, we have had some substantial real economic growth in the U.S. economy over the last 28 months during the most recent economic “recovery.” Yet it is obvious–and Frank has all of the data–that the pool of national “real savings” is a relatively minuscule portion of national income and is declining. So how to explain the growth in real U.S. output?
We can, of course, maintain that the correct definition of “economic growth” simply ought not to include national output expansions financed with credit. (If that’s the case, however, the U.S. hasn’t had economic growth for a very long , long time, indeed. In addition, such a definition does not really allow us to carry on discussions with 99% of the rest of the profession.) Or, alternatively, we can maintain that all of the national income accounting measures are flawed (which they are) and do not describe economic reality correctly.
If we accept the conventional definitions of economic growth, however, clearly there has been “growth” and clearly some of that growth in output has been financed by credit supplied by the Federal Reserve. So it seems to me blatantly false that credit cannot, in fact, generate economic growth. Of course it can and it has many, many times during ALL of the business recoveries since 1917. To deny that it seems to be is silly and gets us absolutely no where with the profession or the businessman in the street.
Thus the question is not “can credit generate growth” but rather “Does credit creation give rise to imbalances in relative prices and the structure of production that EVENTUALLY generates the recessionary phase of the business cycle?” The answer here for most Austrians is “yes” but the unanswered question is what does “eventually” mean in real time. Thus, an important research agenda should be (in the absence of abolishing the Fed) to determine why some expansions in national output are relatively modest and short and why some (the 1990′s) expansions go on for years and years without substantial “corrections.” Clearly the real timing of economic corrections is one of the least understood phenomena in Austrian economics. If we understood the timing mechanism more accurately, the rest of the world would certainly pay our correct theories more attention. It would also be good for our stock portfolios!
Economic growth that is financed by credit is still economic growth. Even though these people who bought goods on credit or mortgaged their house for some reason are going to have to pay back their debts they will probably still be making money enough to continue to stimulate the economy. The fact that people are willing to put more items on credit seems to me that it represents a higher degree of confidence in the economy and the fact that they are going to continue to make enough money or are going to have an increase in their wages.
I don’t think GDP measures economic growth; it provides some indication regarding the consumption of wealth. So the data that is currently available tells us very little regarding the so-called economic growth. All that GDP indicates is the amount of money spent. The more money is printed the bigger the GDP is. The so called real GDP is another non-sense since it is obtained by dividing nominal GDP into non-sensical price deflator. Furthermore, conceptually one cannot even establish total real output, since it is not possible to add potatoes and tomatoes. All that we can say regarding the state of the economy is to assess the damage caused by various government and central bank policies. Various economic data like the level of indebtedness could be used as some kind metaphors for illustration purposes. To conclude then I suggest that Austrian economics provides very accurate answers regarding the consequences of various government and central bank policies. We definitely shouldn’t try to please mainstream economists by treating GDP as some kind of an indicator of the state of the economy. Furthermore, I find it extraordinary that you are suggesting that credit out of thin air can grow the economy. If this were to be the case then poverty world wide would have been eradicated a long time ago.
I think Frank’s right on the meaning of GDP. Neither the expenditures method nor the incomes method of calculating it (and value-added is just another incomes method) really can identify directly changes in real output value. You can’t measure physical output and come up with anything economically meaningful, anyway. And Morgenstern showed the unreliability of price indices decades ago.
Bostaph and Shostak claim–along with Mises and Rothbard–that credit expansion has not facilitated wealth creation and economic growth. Armentano argues that wealth creation and growth have been going on. There is no contradiction between the two positions. Mises has often stated in his time that growth had occured despite credit expansion and other interventions. And how do we separate recessions and depressions from periods of recovery and economic growth? Pull back the curtains, look out of the window.
I have to agree with Evan. He says that economic growth based on the granting of credit still counts as economic growth. How each individual eventually pays back that credit will certainly vary, and short of bankruptcy it will eventually be paid back. The debt will be satisfied at some point whether it be via life insurance paid out, retirement savings, an increase in personal wages, or methodical payments.
Shostak is one of the greatest living economists. I have read most of his work at the mises site and disagree with none of it. We are lucky to have him contribute his work for free. I also suggest listening to his 2 speaches in the “audio” section.
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