Central banks are doing what they can to lift post-crash economies back into growth.
They’re finding it hard because the same force that was so crucial to economic expansion before the credit crunch was also behind the financial markets’ collapse and is now being unwound: bank debt.
And while central banks can force banks to lend, they can’t make people borrow.
This is the thesis presented by Steve Keen, an Australian academic who is fast becoming one of the leading analysts of the financial crisis.
In a nutshell, a normal credit-based economy has three sources of aggregate demand, he argues. One is from income earned by selling goods and services, which in turn largely finances consumption of those same goods and services. Second is entrepreneurial demand for debt, which finances investment. And third, that increase in debt fosters demand for another sort of debt, Ponzi debt, which finances the purchase of assets, driving asset prices higher and, eventually, asset bubbles.
After a big financial crisis, people are reluctant to take on debt, maybe for a generation. Economic growth and asset prices stagnate or trend at lower than previous levels. Eventually they forget the pain debt busts cause and start to borrow again. Banks lend. They will always find a way to fill debt demand and then later find the reserves to justify it.
And the cycle begins again. Debt leads to investment and rising consumption, which leads to debt demand for asset purchases, which leads to rising asset prices and more debt for investment. Ultimately, because credit expansion can’t accelerate forever, the whole thing comes to a messy stop and the private sector deleverages.
And that’s where we are now; in a very long deleveraging process.
The Journal’s Euro Crisis blog provides real-time updates and new takes on important developments as governments and financial institutions deal with Europe’s continuing debt crisis.