Crowding Out During the Industrial Revolution

Peter Temin and Hans-Joachim Voth (2005), "Credit Rationing and Crowding Out during the Industrial Revolution: Evidence from Hoare's Bank, 1702-1862":

Qualitative evidence reinforces the view that quantity rationing was frequent. Hoare's bank told one of its clients who sought to take out a loan that... it could not extend credit:

At present we do not advance Money to anyone on any security.... The uncommon supply of millions and millions granted and now raised [to pay for the Seven Years' War] obliges all of our Profession to be prepared for the Payments [to customers moving their money from the bank into government stock] coming on, so that instead of lending out money, we have called it in on this occasion...

Comments

[Winslow R.]

So what is the point?

A gold standard does not directly limit warfare but instead indirectly through the "crowding out" of commerce in the face of war?

"Crowding out" is no longer an "issue" since money creation is currently independent of gold and therefore warfare is much less limited?

[Nick]

The gold standard... rarely does a term generate as much fervor as that phrase.

But anyways, thank goodness we're not on any kind of gold standard. Fiat money allows the government to more thoroughly steer the economy. I'm not sure what Keynes said about the gold standard, but I'll bet he didn't like it. Limiting the supply of money based on some arbitrary amount of gold just seems weird.

I have no idea what the link between fiat money and war are... except that when a government funding a war (sound familiar?) gets in trouble (i.e., runs unsustainable deficits), then it tends to run the printing presses at greater speed... i.e., create inflation. It's a very effective way to tax the populace (although very evil, because it's extremely regressive).

[Ken Houghton]

Pity they went off the gold standard in time for WW II.

"And how is Mrs W.?"

[derrida derider]

Nick, Keynes famously dismissed the gold standard as "this relic of barbarism".

[Auros]

Winslow, I think the most basic take-away lesson is that massive government borrowing -- whether for war or other purposes -- crowds out private borrowers trying to finance entrepeneurial ventures, and thus presumably slows the growth of the economy. Additionally, in a global, rapidly-changing marketplace, a country where entrepeneurship is slowed in this manner will be less able to adapt to changing circumstances and maintain its relative advantages.

[jtt]

Wait. I thought inflation was actually PROgressive. At least as long as wages more-or-less keep up. I'd be happy if we had a nice 70s-style inflation: It'd be MUCH easier to pay off my consumer debt, mortgage and student loans with cheaper dollars!

People remember the late-70s as some sort of Dark Age, but in fact, it was quite a happy time economically for certain segments of the middle and lower class. For instance, people who bought houses at moderate fixed rates in the early and mid-70s were doing quite well by the early 80s. Sure, it was a tough time for bond holders but, then again, it set the stage for the mid-80s bond market.

[Winslow R.]

Auros wrote:

"I think the most basic take-away lesson is that massive government borrowing -- whether for war or other purposes -- crowds out private borrowers trying to finance entrepeneurial ventures"

Yes , I suppose that may have been Brad's point though it is a "fraud".

My point is a fiat money system is not a gold standard and therefore has only self-imposed constraints on borrowing. Currently government borrowing does not limit war or commerce because financial assets can be produced in unlimited quantities.

Why is this "confusion" promoted?

My guess it has something to do with jtt's post.

"in fac, it [the 70's] was quite a happy time economically for certain segments of the middle and lower class."

Something John Kenneth Galbraith might call "Innocent Fraud".

In essence, Galbraith says that the Fed, for all of its power and prestige, effectively does nothing. And he has little problem with this: "Let their ineffective role be accepted and forgiven."
http://www.wirtschaftsvereinigung.de/0618013245.html

Fiscal policy is the "strong force" compared to monetary policy which is a "weak force". The banks (monetary policy) can drop rates to zero as in Japan and nothing will happen. The Japanese goverment's (fiscal policy) willingness to spend is what saves Japan from depression.

When will we get a Professor that will admit inflation will likely be the way (taxes would be better) our economy will correct the huge wealth imbalance that currently shackles our (U.S., Japan, Europe) economy?

[Auros]

Well, the problem with trying to inflate away debt, currently, is that a huge portion of the general public's debt is adjustable -- credit cards, ARMs, etc. I'm not sure how much gov't debt is held in inflation-protected bonds, and how much would go away if they started running the presses, but my impression is that the inflation-protected bonds are a small portion of the total. Nonetheless, just running the presses wouldn't help us much unless we also raised taxes, because under current circumstances, we need to roll over a lot of our bonds, and nobody will buy the new issues at current interest rates if we do that.

[rjw]

I' m always puzzled by the mechanisms at work in these crowding out arguments. It seems to be assumed that it is "obvious" how crowding out works, but it is not really. Why might a government deficit directly reduce credit? I can think of the following reasons:

- banks decide to hold govt stock not loans on the asset sides of their books, and if their capital is fixed, this leaves less capital to underpin new loans (= credit crunch). But not a problem if banks can expand their capital base fairly elastically.

- a government deficit drains reserves from the banking system which may lead directly to higher rates on bank reserves (and thus loans) and to rationed credit (though not if the government reinjects reserves by actually spending the cash it has borrowed)

- the portfolio effects of an increase in the increase in debt stock, relative to the money supply, is such as to drive up rates on debt. (the classic IS-LM style argument, though empirically it seems to vary with the seasons)

- in a less developed financial system - one might imagine that an individual bank, facing a loss of reserves as customers withdraw funds to buy stock would have to restrict loans if the inter-bank market was not developed enough to recycle the reserves.( and thus allow the bank to easily find new funds to underpin its loans)

A more direct crowding out argument is that higher government spending makes use of resources that could be used by the non-govt sector ("real crowing out")
But this assumes no/little spare capcity. And this is not a direct credit channel.

But these are all different mechanisms - that may be more or less powerful in different stages of development, and/or under different monetary regimes, and a host of other stuff. For this reason, crowding out is another term I'd prefer to see less used by economists. Another term widely used that everyone "assumes" is well understood, but is not

In fact - in this respect it is a little bit like the expression "global saving glut" (haven't I heard that somewhere recently?)

[wow]

you guys don't know anything!!!!

[jerry]

Here we are in 2008 with our shiny fiat money supply, and guess what!?

CREDIT CRUNCH!