New path?

Growth Without New Debt

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Borrowing is down among those who saw the value of their homes drop but confidence may be increasing.
  • Why it matters

    Why it matters

    • The euro zone’s economy is possibly on the way toward a sustainable, less credit-dependent growth model, the author argues.
  • Facts


    • An analysis shows the growth model of the past two decades, in which lending grew consistently faster than gross domestic product, in historical observation was more of an outlier.
    • Since the recent great recession, many households and companies are cautious about taking on more debt.
    • The next economic recovery is likely to be accompanied by lower credit expansion, but that doesn’t mean economic growth must also be lower, the writer says.
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The European Central Bank has been flooding euro zone banks with liquidity for years so they can make more loans. There are some signs of the success of this endeavor. Recently, bank lending was only about 1 percent lower than in the same month last year. The trend of the past few months seems to suggest lending may increase again soon in the euro zone.

The question is whether this positive trend is more a consequence of an economic recovery in the crisis countries, rather than a cause of the ECB’s policies.

The sequence of events indicates that first, confidence returned in the economic outlook and the financial system – and loans were issued afterwards, thanks to this confidence, and also, relatedly, to the ECB’s bank stress tests.

The view that only increasing lending would point the way out of the recession in many parts of the euro zone is probably too narrow.

Those who think so overlook the fact that, firstly, low confidence in the economic outlook inhibits investment and with it demand for credit, even at very low interest rates. In the euro zone, this means that without structural reforms and sustainable economic policy, investors will seek their fortunes elsewhere.

Secondly, after repeated bad experiences with excessive credit expansion, companies have opted to finance investments primarily using their own means. They are sitting on considerable cash reserves and can also raise new capital in the stock market relatively easily. That means in terms of extending credit, this economic cycle could take a different course to previous ones.

The euro zone’s economy could well be already on the way towards a sustainable growth model, which is less dependent on credit. That doesn’t mean it’s a case of the dreaded “secular stagnation” opposed by economists in the United States and United Kingdom, but rather a return to normalcy. A recent analysis by Oxford Economics found that the growth model of the past two decades, in which lending consistently grew faster than gross domestic product, was more of an exception in a historic context.

Countries where households and businesses have many years of a painful debt reduction behind them learn – as the United States did following the great depression of the 1930s.

In contrast, in the post-war decades in the most important industrial countries, borrowing little more than a dollar in the private sector, excluding banks, was mostly sufficient to generate $1 in additional gross domestic product.

In many countries, this ratio changed in the mid-1990s and lending began to rise sharply, almost endlessly, only to end with the financial crisis in 2008 in most countries, such as in the United States and United Kingdom. In countries such as France and the Netherlands, the borrowing trend continued.

Countries where households and businesses have to put a period of painful debt reduction behind them tend to learn a lesson – as the United States did following the Great Depression of the 1930s. For decades afterwards, U.S. households and businesses barely borrowed. The same can be expected here.

This can be seen in Japan, where the central bank and government failed to persuade people to borrow more and increase consumption because people remembered the credit-bubble bust of the 1990s. In Spain and Ireland, people will be much more cautious in the short term. Anyone who experienced such a huge drop in housing prices will think twice about a taking on another big loan to buy a home. Regulatory authorities worldwide are also trying to ensure no such bubbles occur in any economic sector.

This suggests the next economic recovery will be accompanied by lower credit growth. That might also keep interest rates low in the long term. But that doesn’t mean economic growth will necessarily also be lower than in the past. After all, growth rates were higher in decades when credit volumes grew in line with economic performance than in the past two decades.


The author is a managing partner of the Handelsblatt Research Institute. He can be reached at:

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