Bank Lending Causes Growth?

Of course it does. If banks restrict their lending, it has an effect on aggregate expenditure as producers will postpone their plans and consumers might spend less. If banks increase their animal spirits, and lend more, producers and consumers borrow more with effect on aggregate demand and output.

But is growth only caused by bank lending?

In a recent article on Brexit, Richard Werner says:

I have been trained in international and monetary economics at the London School of Economics and have a doctorate from the University of Oxford in economics. I have studied such issues for several decades. I have also recently tested, using advanced quantitative techniques, the question of the size of impact on GDP from entry to or exit from the EU or the eurozone. The conclusion is that this makes no difference to economic growth, and everyone who claims the opposite is not guided by the facts. The reason is that economic growth and national income are almost entirely determined by a factor that is decided at home, namely the amount of bank credit created for productive purposes.

But this logic is carrying the logic in my first paragraph too much. Causality is a complicated issue. Banks don’t lend without thinking anything about its customer. Werner even claims that he has confirmed it with causality tests. But these tests have their own fallacies such as post hoc ergo propter hoc.

Let’s take a specific example. Suppose, I make a robot which does all household stuff for you, such as cooking food, washing your clothes and ironing them and keeping them back in your wardrobe. Basically any household stuff. Suppose I also make it difficult for anyone to replicate or copy it. My product – the robot – will sell like hot cakes all over the world, if the pricing works out cheap. The sales of my firm will benefit employees and stock holders and it will greatly benefit India, where I reside. Banks will lend me of course but it’s clear that the causality of the rise of output is more my innovation and not bank lending. More generally one can ask other questions: how was I successful in innovating? Perhaps my education was subsidized and I did most of my research was carried out in a university before I corporatized the idea.  Or maybe I paid employees a lot which made them productive.

There can be various other reasons, such as a fiscal expansion causing a rise in domestic demand and output, leading banks to lend more when they spot the trend and are confident of their lending. In that case, you could say that fiscal policy caused growth.

Post Brexit, two important things can be identified – which have already been talked about such as by the UK Treasury or NIESR. They are UK trade with the EU and migration. Migration is a complicated subject. If the UK regulates low skill migration, wages can rise and will contribute positively to aggregate demand. Allowing high skill migration to continue can keep UK firms competitive in international markets. Trade tariffs have to be renegotiated with the EU. UK politicians can ignore the message of the referendum result and reduce tariffs or, they can raise tariffs. A lot depends on how the political climate evolves. Just saying growth depends on bank lending implies that these trade and migration policies have no impact, which is completely wrong.

tl;dr summary: causality is a complicated subject.

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