ONE thing about public opinion I fail to understand is this: people understand that easy credit was a cause of the financial crisis, so why are policies that make credit easier popular? George Osborne’s credit easing plans for small businesses are noble in that these firms are indeed the lifeblood of the economy. But it is not at all clear that the benefits of government intervention outweigh the costs.
People suspect that rather than lending money, banks are sitting on it. This is possible. This would be a supply constraint in the credit market. But it is also possible that the credit market is suffering from demand constraints. Perhaps people now want to take on less credit than in the recent past, either because they are uncertain about their future income streams, wish to pay off debt, have an inability to plan due to policy uncertainty, or simply are experiencing a decline in animal spirits or confidence. It’s not obvious whether a lack of lending reflects tightfisted banks or pennywise consumers.
It is the role of banks to sort this puzzle out. As middlemen between savers and borrowers, they must allocate credit as efficiently as possible. And believing that banks fail at the task of financial intermediation is no different to believing that supermarkets are unable to bridge the market between producers of potatoes and consumers, and suggesting government step in to ease the spud supply.
When I participated in a project on small and medium-sized enterprise (SME) financing for the European Investment Fund we found no shortage of entrepreneurs who highlighted a lack of financing. They blamed supply constraints. But we also interviewed banks, and discovered they couldn’t find enough sound business plans to lend to, a limit on the demand side. Entrepreneurs that complain about access to finance are like batsmen complaining about the high quality of bowlers – it’s not a market inefficiency, it’s the reason you have a job.
Politicians should pay more attention to punitive taxation and regulatory burdens that stifle entrepreneurial energy. Instead, they think the answer is to inflate the currency to provide more credit. But ultimately, the costs of subsidised credit hit home hard. The problem before the recent crisis wasn’t that well-run businesses struggled to get credit: it was that they were forced to compete with poorly-run businesses that found credit plentiful.
J. Huston McCulloch says in Money and Inflation that “the revenues from inflationary finance are shared by the government, the owners of the private banks, and the nongovernmental borrowers from the banking system, such as corporations and homebuyers.” Today, mortgage rates have been – and still are – historically low, and the availability of credit is so plentiful that people can rack up several thousand pounds on a credit card without anyone even knowing.
The only way forward is to recognise that interest rates are too low and that credit – like any other good – needs to be allocated among alternate uses. This can only begin to happen once the government takes a step backwards and allows genuine financial intermediation to take place.
Anthony J. Evans is Associate Professor of Economics at London’s ESCP Europe Business School, and Fulbright Scholar-in-Residence at San Jose State University. His website is www.anthonyjevans.com.