Abstract
The financial crisis of 2007–2008 triggered monetary policy designed to boost nominal demand, including ‘Quantitative Easing’, ‘Credit Easing’, ‘Forward Guidance’ and ‘Funding for Lending’. A key aim of these policies was to boost the quantity of bank credit to the non-financial corporate and household sectors. In the previous decades, however, policy-makers had not focused on bank credit. Indeed, over the past half century, different variables were raised to prominence in the quest to achieve desired nominal GDP outcomes. This paper conducts a long-overdue horse race between the various contenders in terms of their ability to account for observed nominal GDP growth, using a half-century of UK data since 1963. Employing the ‘General-to-Specific’ methodology, an equilibrium-correction model is estimated suggesting a long-run cointegrating relationship between disaggregated real economy credit and nominal GDP. Short-term and long-term interest rates and broad money do not appear to influence nominal GDP significantly. Vector autoregression and vector error correction modelling shows the real economy credit growth variable to be strongly exogenous to nominal GDP growth. Policy-makers are hence right to finally emphasise the role of bank credit, although they need to disaggregate it and specifically target bank credit for GDP-transactions.
Highlights
One highly useful lesson from the crisis is that we conventionally use the label “monetary policy” to refer to the macroeconomic policy that central banks carry out, the way this policy works revolves around credit, not money
Since past occurrences of YoYCreditRE can be excluded from the Year-on-year nominal GDP (YoYGDP) vector autoregression (VAR), we can say that YoYCreditRE is strongly exogenous of YoYGDP as we showed in Section 4.2.2 that it was weakly exogenous
The Long-term Interest rate (LT Rate) itself appears independent of the other variables with the exception of YoYGDP which we would expect in a monetary policy regime which has been mainly focused on inflation for most of the period under question
Summary
One highly useful lesson from the crisis is that we conventionally use the label “monetary policy” to refer to the macroeconomic policy that central banks carry out, the way this policy works revolves around credit, not money. The focus on intermediate variables means that the effects on the final target variable of nominal GDP is hypothesised rather than empirically tested – using concepts such as ‘portfolio rebalancing’ (Section 2.2) Another problem with existing studies is the time period over which analysis is conducted. A third problem is that many studies do not include credit aggregates or distinguish where credit flows in the economy This is a criticism that has been levelled at macroeconomic theory and macroeconomic models more generally, most of which excluded a significant role for money, credit or banks (Buiter, 2008; Goodhart, 2009; Turner, 2013a). We examine the impact of various different monetary policy variables, including a real-economy disaggregated credit variable, in a general unrestricted single-equation model with nominal GDP growth as the dependent variable..
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