Edward Hadas points out that long-term credit growth has exceeded growth in nominal GDP (real GDP plus inflation) in the US and Europe for some time. Not only does this fuel a credit bubble but it leads to a build up of inflationary pressure within the economy. If not evident in consumer prices it is likely to emerge as an asset bubble.
For the last two decades, accelerating credit has been closely correlated with the change in GDP – both in the United States and the euro zone. GDP growth tended to speed up shortly after the rate of credit growth increased, and slowed down after credit growth started to decrease.
This correlation implies there is an equilibrium rate of credit growth – the rate that corresponds to the long-term pace of nominal GDP growth. Though the pace of credit growth can vary from year to year, over time private debt and nominal GDP have to expand at the same rate for overall leverage to stay constant. That’s not what happened in the past two decades. Since 1990, Deutsche found a significant gap between credit and GDP growth in the United States and the euro zone.
In both, the neutral rate of credit growth – the rate associated with the economy’s long-term growth rate – was 7 percent. Those long-term nominal GDP growth rates were lower: 4.8 percent in the United States and 4 percent in the euro zone. In a single year, the difference of 2-3 percentage points doesn’t have much effect. Over a generation, though, it leads to a massive increase in the ratio of private debt to GDP.
The gap between growth in Domestic Debt and Nominal GDP widened in 2004/5 during the height of the property bubble and has narrowed to near zero since 2010.
Hopefully the Fed have learned their lesson and maintain this course in future.
