Credit easing

The expression "credit easing" was first used prominently by the chairman of the Board of Governors of the US Federal Reserve System (Bernanke, 2009). In his speech at the London School of Economics, Bernanke (ibid.) subtly criticized the Japanese central bank and its attempts at monetary stimulation, arguing that the Japanese policies were not the best way to help the economy after a banking crisis, and that he had been implementing a different policy, which also aimed at expanding the quantity of money available, but was targeting credit availability more directly.

The expression "credit easing" derives indeed from the expression "quantitative easing", which itself originates in Japan. The Bank of Japan (BoJ) was the first central bank to adopt a policy by that name, describing its actions between 2001 and 2006 (label- ling these as "quantitative easing" retrospectively since about 2003; see Lyonnet and Werner, 2012).

As these policies consisted largely of increasing banks' reserves at the central bank - that is, standard monetarist narrow money expansion ("reserve expansion", "high- powered money expansion") - it was surprising that the BoJ chose to use this relatively new label for such a well-established policy, known under other names. The reason for this must lie in the older genesis of the expression "quantitative easing", which had origi- nally been used to describe a policy of expanding credit creation for GDP transactions, in accordance with the quantity theory of credit (Werner, 1995). This policy is designed for the aftermath of banking crises, and presupposes an understanding of the causes of the crisis: they are produced by excessive credit creation for transactions that do not contrib- ute to GDP, namely financial and asset transactions, including property and real estate.

Werner (1994, 1995) had argued that the traditional monetary policy of lowering inter- est rates was not likely to work in a post-asset bubble banking crisis cum recession, when banks are burdened with bad debts and hence reducing credit creation. He argued that interest rates follow nominal GDP and thus cannot be used to stimulate it. Instead, poli- cies needed to be adopted in order to expand bank credit creation for GDP transactions, as this would boost nominal GDP growth. As Werner (1995, 1996, 1998) argued, these policies are:

(1) Central bank purchases of non-performing assets from banks at face value (or at least significantly above any imputed market value), while not marking them to market.

(2) Central bank purchases of assets from the non-bank private sector in order to support those asset markets and stimulate purchasing power in the economy.

(3) A switch of the method to fund the public sector borrowing requirement from bond issuance to entering into loan contracts with the domestic bank (on a pro-rata basis), thereby increasing bank credit creation for GDP transaction directly (and often, as would have been the case in the euro area, doing so at lower interest rates, as the interest rate in the market for bank credit can be significantly lower than bond market yields).

(4) Selectively relieving or suspending Basel capital adequacy rules in order to encour- age banks to increase lending for small and medium-sized enterprises and the real economy.

(5) Introducing a regime of credit guidance to ensure an expansion in productive bank credit, while suppressing harmful and unsustainable speculative credit.

Werner (1995, 1996, 1998) also argued that expanding high-powered money (bank reserves) was not likely to stimulate the economy. The BoJ agreed with the latter assessment of reserve expansion policy in a number of publications until and includ- ing February 2001, only one month before it adopted such a policy of increasing bank reserves. As BoJ staff Fujiki et al. (2001, p. 99) noted in February 2001, "providing additional monetary base by orthodox operations [. . .] does not affect [. . .] interest rates or amount of lending. In other words, providing monetary base [. . .] is not an effective monetary easing measure". Why the BoJ thus chose to restrict itself to such a policy, which it agreed with Werner would not work - and to use the expression "quantitative easing" to describe it, although it was already known as standard "reserve expansion" - is puzzling. It possibly could have been an attempt to discredit the original "quantitative easing" proposal - although that would be a macabre use of monetary policy, at the cost of large-scale unemployment.

Under Bernanke, the US Federal Reserve in September and October 2008 adopted key tenets of the original "quantitative easing" proposals by Werner (1995, 1996), notably large-scale asset purchases from banks. In order to differentiate his policies from the failed policies of reserve expansion adopted by the BoJ (even though confusingly called "quantitative easing"), Bernanke chose to use a modified expression, which emphasizes the core principle of Werner's proposals, namely to expand credit creation. Bernanke thus coined the term "credit easing". Ironically, he thereby returned to the original meaning of "quantitative easing" (Werner, 1995), which was defined as an expansion in credit creation ("credit easing"), focusing on the assets side, not liabilities (reserves). This may not be by coincidence: Bernanke was an active participant in the debates on Japanese monetary policy in the 1990s.

Meanwhile, the Bank of England also adopted a policy it called "quantitative easing" in March 2009. It varied from the BoJ's version, and was more in line with Werner's definition in another respect: it conducted asset purchases through a subsidiary (so they would not have to be marked to market) that purchased them from the non-bank private sector. However, the Bank of England failed to buy nonperforming assets from banks, therefore forcing the government to step in and purchase bank equity and bank assets - a far costlier method, resulting in an expansion of government debt and consequent fiscal retrenchment.

Reflecting criticism of its policies (see Lyonnet and Werner, 2012), the Bank of England announced a policy called the "funding for lending scheme" in 2012, which for the first time targeted "lending to the 'real economy'" (Churm et al., 2012, p. 309), to wit, the variable emphasized by the quantity theory of credit. Further, the Bank of England adopted first steps towards credit guidance in its monetary policy measures announced on 26 June 2014 (Bank of England, 2014), in line with Werner's recommendations.

Likewise, the European Central Bank, having been briefed on the necessary post-crisis credit expansion policies (see Werner, 2011), finally adopted measures towards such poli- cies on 5 June 2014, by incentivizing banks to increase "lending for the real economy", defined as "lending to the euro area non-financial private sector, excluding loans to households for house purchase" (European Central Bank, 2014). As there is no other monetary or macroeconomic theory that disaggregates credit for the real economy (GDP transactions) and credit for non-GDP transactions, it can be said that the quantity theory of credit has gained wider acceptance in the post-crisis years in the United States and in Europe.

See also:

Basel Agreements; Bernanke, Ben Shalom; Credit creation; Credit guidance; Quantitative easing; Quantity theory of credit.