It looks like Schularick and Taylor — along with most of the rest of the economics profession — need to brush up on their Ralph Hawtrey and Benjamin Strong reading. (Note that there’s a short version of the paper at the Economists’ Forum.) They state: “Our ancestors lived in an Age of Money, where aggregate credit was closely tied to aggregate money, and formal analysis could use the latter as a reliable proxy for the former.” While it is possible that early central bankers could have relied on money as a proxy for credit, the fact is that they did not. In fact, I can’t help but wonder Schularick and Taylor have their causality backwards: Perhaps it was because early central bankers focused equally on credit growth and on price levels, that they maintained a relatively stable relationship between credit and money.
The evidence that early central bankers focused much of their attention on the state of credit is overwhelming. Early central bankers didn’t even view themselves as implementing monetary policy, they implemented credit policy. In Hawtrey’s The Art of Central Banking published in 1932, credit and money are given equal emphasis. Similarly in Interpretations of federal reserve policy in the speeches and writings of Benjamin Strong, we find that Strong wrote in 1923:
Some people think that prices should be the guide …
Just as credit is one of the influences upon the price level, so the price level should be one of the influences in guiding a credit policy. There are other influences which affect prices, and so there must be other influences which affect a credit policy. Here are a few briefly suggested:
Is labor fully employed?
Are stocks of goods increasing or decreasing?
Is production up to the country’s capacity?
Are transportation facilities fully taxed?
Is speculation creeping into the productive and distributive processes?
Are orders and repeat orders being booked much ahead?
Are bills being promptly paid?
Are people spending wastefully?
Is credit expanding?
Are market rates above or below … Bank rates?
What this country and the world needs is stability. … The banking system’s … best policy is to supply enough credit and not too much — enough for legitimate enterprise, but not enough to satisfy those who want simply cheap and limitless supplies of credit regardless of the consequences they are too blind to perceive.
So when Schularick and Taylor find that:
Our results also strengthen the idea that credit matters, above and beyond its role as propagator of shocks hitting the economy. The credit system is not merely an amplifier of economic shocks as in the financial accelerator model of BGG. The importance of past credit growth as a predictor for financial crises and the robustness of the results to the inclusion of other key macro variables, raises the strong possibility that the financial sector is quite capable of creating its very own shocks.
we learn that careful empirical research in the 21st century can confirm traditional principles that central bankers recognized in the early years of the 20th century.