Getting it wrong on credit conditions

I've been obsessed for a while with the idea that credit availability is a much smaller factor in the current downturn than is widely believed -- that the focus on bank balance sheets as a key constraint on output and employment is a symptom of the intellectual capture of economic discussions by Wall Street.

Here's a perfect example from the generally good Gretchen Morgenson of the Times. Morgenson writes:

All that debt overhanging consumers and organizations is the pivotal reason we are still seeing a free fall in bank lending. And small businesses, which account for half of all jobs in this country, are taking the brunt of this credit contraction. Smaller banks are especially worried about their own balance sheets and aren’t making loans. This puts small businesses ­ important engines of growth ­ squarely on the brink.

In its survey, the [National Federation of Independent Businesses] asks small businesses how easy it is for them to get loans. The most recent data shows that credit tightness peaked earlier this fall ­ the worst levels in 23 years, Mr. Shepherdson says. Although credit continues to remain troublingly hard for small business to come by, that phenomenon is a largely untold story.

So let's take a look at what that NFIB report actually says. Yes, on p.12-13 it reports that the net percent reporting easier credit conditions was -14 percent in October, compared with just -4 percent five years ago; in July, the percent saying they had satisfied their borrowing needs over the past three months bottomed out at 29%, with 10% saying their borrowing needs were not satisfied. (The balance didn't need to borrow.)

But!

Turn to p. 14 and you see that the interest rate paid by small business on short-term loans was 6.0%, down from 9.5% in May 2007. On p.6, we learn that of the half of small business owners who report lower earnings this month, 62% say it's because of reduced sales and another 8% to price cuts; only 13% cite rising costs, including labor, materials, taxes, and regulatory costs as well as finance costs. And then on p. 18 they ask small biz owners what is their most important problem. Sales, 33%; taxes, 22%; government regulation, 11%; competition from big business, 6%; and finally financing, tied with cost and and quality of labor at 4%. Compare this to the early 80s, when nearly 40% cited financing as their single most important problem.

Here's how the NFIB itself summarizes these findings:

Overall, loan demand remains weak due to widespread postponement of investment in inventories and record low plans for capital spending. In addition, the continued poor earnings and sales performance has weakened the credit worthiness of many potential borrowers. This has resulted in tougher terms and higher loan rejection rates (even with no change in lending standards), and there is no rush to borrow money ... It sounds like the Administration thinks the reason small firms are not hiring is that they are not able get credit. Although credit is harder to get, 'financing' is cited as the 'most important problem' by only four percent of NFIB’s hundreds of thousands of member firms. ... Record low percentages cite the current period as a good time to expand, more owners plan to reduce inventories than to add to them, and record low percentages plan any capital expenditures. In short, the demand for credit is in short supply and failing to understand the more major problems facing small business leads to bad policy. ... What small business needs is customers.

Gretchen Morgenson is one of the better business reporters out there, as far as I can tell. So how could she take a report that explicitly says that credit availability is not a major problem for small businesses and turn its findings around 180 degrees? And of course, this has implications for the shaping of policy. The NFIB's story leads to the conclusion that what's needed is government action to raise final demand. But in Morgenson's version, it turns into an argument for further capital injections into the banking system instead. That's how strong is the intellectual hegemony of finance. Stories that don't end with the moral "... and so banks need more money" just do not get told.

GDP skepticism from the Fed

Interesting article by Bart Hobijn and Charles Steindel of the New York Fed, on alternative measures of GDP growth.

They make adjustments for three familiar problems -- the non-inclusion of household labor, the calculation of government output as equal to cost, and the treatment of R&D (and other "intangible capital") spending as an intermediate rather than capital good. The first issue is self-explanatory; the second is equivalent, for purposes of measuring growth, to an assumption of constant productivity in government; and the third means that R&D expenditures are not counted in final output. Hobijn and Steindel adjust for these problems by adding R&D-type expenditures to GDP; assuming that about one-quarter of women's wages represents the market value of foregone household labor (don't ask me how they came up with that number, or how they decided that men's household labor has no value); and assuming that government productivity grows at the same rate as for the nonfarm business sector.

Their results? For 1983-2003, the adjusted and published series correlate almost exactly (0.99) at an annual level. (This isn't surprising given how the adjusted series is constructed.) But over time, the divergence is significant -- the upward adjustments for government productivity and the faster growth of R&D expenditures compared with GDP outweigh the downward adjustment due to a rising proportion of women in the workforce. So annual growth over those two decades runs about 0.5 percentage points, or 15 percent, higher with the adjusted series than with the published one. That's not a trivial difference.

This is obviously of interest to anyone working on constructing alternative measures of GDP. But to me it raises bigger conceptual questions (questions that Hobijn and Steindel don't get into, of course, since being mainstream guys they're chasing the mirage of "welfare"). If short-term fluctuations are robust to alternative measurements but long-term growth is not, shouldn't quantitative economics focus on the former? Is there a firm conceptual basis for talking about long-term growth as something we can even measure at all? Or was Keynes right when he said,

To say that net output to-day is greater, but the price-level lower, than ten years ago or one year ago, is a proposition of a similar character to the statement that Queen Victoria was a better queen but not a happier woman than Queen Elizabeth — a proposition not without meaning and not without interest, but unsuitable as material for the differential calculus.