Sunday Times economics editor David Smith argues for a government-directed expansion of bank lending to the corporate sector and house purchasers to accelerate economic recovery. It is far from clear that such an initiative is necessary and it could prove counter-productive.
The financial surplus of private non-financial corporations (i.e. the excess of retained earnings over capital spending) was £22.9 billion or a record 6.2% of GDP in the fourth quarter of 2010 – see chart. Firms in aggregate have more than sufficient internal resources to fund expansion. A contraction in aggregate corporate bank borrowing is neither surprising nor concerning against this backdrop.
Some SMEs with good business prospects may be unable to access credit but there is little evidence that the problem is widespread or critical. In the CBI’s April survey of manufacturing SMEs, 9% of firms stated that capital spending plans were likely to be constrained by an inability to raise external finance compared with 54% citing uncertainty about demand as a negative factor. The 9% figure was just one percentage point higher than in the companion large-firm survey.
Government-mandated credit quotas risk forcing banks to lend to financially-weak companies with poor long-term prospects, raising the spectre of a Japan-style scenario in which “zombie” firms on official life support divert resources from more productive activities, slowing economic growth.
A forced increase in mortgage lending, meanwhile, would probably serve mainly to boost house prices rather than new construction or economic expansion.
Mr Smith’s claim that broad money growth of 1.5% is “inconsistent with sustained recovery” ignores the possibility that the velocity of circulation has embarked on a sustained upswing – it rose by 3.7% annualised between the second quarter of 2009 and the first quarter of 2011. When real interest rates were last heavily negative in the 1970s, velocity rose by a cumulative 38.6% over six years, or 5.6% annualised. Such a rate of increase, combined with 1.5% money growth, would support strong economic expansion and a continued inflation overshoot.
