Easy credit and tight money
By Scott Sumner
The title of this post is the shortest description I could come up with for the global economy circa 2019. Because these two concepts get confused, a short explanation is in order.
The best way to judge the stance of monetary policy is by looking at the growth rate in “M*V” aka nominal GDP. By that criterion, money has been tighter than average in America, and even more so in Europe and Japan. That helps to explain low nominal interest rates, but it’s not the whole story.
It’s less clear how we should measure credit market tightness. I’d like to suggest looking at the difference between NGDP growth expectations and nominal interest rates.
Unfortunately, we don’t have a precise measure of NGDP growth expectations, but recent trends in many countries show NGDP growing at rates much higher than the current level of risk-free interest rates. Normally you’d expect those two rates to be closer together. Thus credit is currently relatively easy by historical standards. (Of course the low interest rates might be a prediction of recession, but they’ve persisted for quite some time.)
One of the best examples of easy credit is Sweden, where NGDP growth has averaged close to 5% since 2014 (high by European standards), but interest rates have been negative since 2015. The FT has an article discussing Sweden’s situation. They point out that Sweden’s monetary policy has achieved good results. With inflation close to 2% and unemployment is low by historical standards, Sweden has done better than the eurozone. The Swedish krona has been weak. Housing has been especially strong.
Nonetheless, there is a lot of frustration with Sweden’s low interest rate policy, with some calling for the abandonment of the 2% inflation rate target. While inflation targeting is not optimal, many of these critics are confused. They seem to believe that Sweden has ultra low rates because of an easy money policy aimed at 2% inflation, and that a tighter policy would lead to higher interest rates. Actually, the long run effect of tighter money is lower nominal interest rates.
It’s easy to understand the frustration. I certainly would not have expected 5% NGDP growth to lead to such low interest rates. We live in an easy credit world for reasons that I don’t fully understand, although it’s obviously some combination of high saving and low investment. Can’t we just look at the numbers? No, actual realized saving equals investment. There have been shifts in the saving and investment schedules that, taken together, have led to much lower interest rates without much change in the quantity of saving and investment.
Given the strength of the Swedish housing market, I’d guess it’s a combination of low non-residential investment demand and a higher propensity to save, but a lot more research needs to be done in this area.
Don’t draw the wrong policy implications from easy credit. If it is a “problem” (I’m not sure it is), it can’t be solved with monetary policy. Governments could think about removing regulatory barriers to investment in housing, infrastructure and other useful activities. If NGDP is growing at 5%, why can’t entrepreneurs find more useful things to do with money borrowed at near zero percent? What’s changed from earlier decades?
In Denmark, mortgage rates are minus 0.5%. Someone in Copenhagen could take out a $1,000,000 (equivalent) mortgage, put the cash in a safe in their basement, and earn a $5000/year risk free profit. That seems crazy. So don’t get me wrong, I see why people instinctively feel there is something wrong here. It’s just that the “something wrong” in places like Sweden and Denmark doesn’t happen to be monetary policy.
PS. This is not a new issue. In 2012, I did a blog post entitled “Tight money, easy credit”.
PPS. Yes, I understand that fire and theft risk would prevent the Danish arbitrage I describe, but it still highlights the craziness of the situation.