Which Comes First: Loans or Growth?

A couple weeks ago Noam Scheiber posted an article to his TNR blog “The Stash” about an interesting debate going on in the financial world: Do loans drive economic growth or does economic growth increase demand for loans?

An April 8 WSJ article by David Gaffen suggests: “Loans can fuel economic activity, but it takes a certain level of economic activity to fuel demand for loans.” Scheiber suggests though that we can’t just let lending stop and wait for growth. Yesterday, he reiterated that point saying, “While the banks aren’t exactly expanding credit, they’d be massively contracting it without TARP, which would be an economic disaster.”

I very much respect Scheiber’s contention that wealth must be driven by financial stimulus (and I mean that in terms of banks stimulating growth through loans, apart from the government). Finance, investment, capital venture–all of this has been critical in helping build American wealth.

But something is being ignored here. Banks were loaning too much money, on too loose of credit standards. Credit has tightened up because it was extended too far and now has coiled back. We want sustainable growth, but we won’t get that if we try to push the banks back to the same lending positions they were pre-recession/bubble bust.

It would seem implausible that increasing national debt is the path to fiscal stability, but, as many argue, things could be different in a financial crisis. Trusting in the limited government principle that many libertarians hold to, I am hesitant to create new rules during a crisis, even if it seems to provide easier answers. But we’re not looking for the easy answer, we’re looking for the right answer, the right response. That of course leads to a separate debate about whether to govern from particulars or principles, which I won’t do here.

Follow the loan/growth-chicken/egg debate here.

Anthony Randazzo

Anthony Randazzo is a senior fellow at Reason Foundation, a nonprofit think tank advancing free minds and free markets.