Bank Lending Outweighs Consumer Sentiment

by: Modeled Behavior

By Karl Smith

I do want to get to the NGDP petition today, but the following actually relates to a lecture I am giving this morning.

At least causally, we have long thought of consumer sentiment as being an important determinant in spending. This has always struck me as contrary both to human nature and economic principles. I’ve said that consumer spending is held in check by a single phrase: “Your application for credit has been denied.”

Indeed, the very fact that banks turn away paying customers – rather than simply raising the price on them – I think is key to understanding the business cycle. Its one of those odd but key facts that tells us something important is going on under the surface. Similar is the fact that the spread on prime adjustable-rate mortgages is higher, not lower, than prime jumbo 30-year.

On the surface this makes little sense, given the huge embedded option in the 30 year mortgage. This tells us something is odd about ARMs, and since, in an environment of falling home prices, fixed-rate mortgage debt becomes a radically sticky price, this tells us something important about how economies get themselves into rough shape.

But, enough of all that, you come to Modeled Behavior for charts. Here is growth in real retail sales versus consumer sentiment:

FRED Graph

Pretty good. But, here is growth in real retail sales vs. a survey of senior loan officers' willingness to issue new consumer installment loans.

FRED Graph

Consumer sentiment would tell you that retail sales should be in the toilet. Bank willingness to lend should tell you they are surging, and indeed, they are surging.

This is why I believe that bank willingness to lend, not consumer willingness to spend, is what matters.

Further, I think when you put bank lending front and center, and combine that with Fed policy, you see that “savings” is not as meaningful a concept as we might think.

The amount of savings in the economy is a result of what goes on in capital markets and – I think – consumer behavior can only impact this through effects on inflation. Changes in consumer behavior will change the relationship between savings and inflation, but it's not really correct to think of savings as being determined by consumer behavior.

This is all kind of hazy, and I depend on Brad Delong to point me to important historical references of people having worked all this out before.

Also as a side note: I am always open to advice and criticism, but I think Brad Delong misunderstands me. I am not suggesting that some jobs do not create value, but that we are currently experiencing a job crisis, not a value-producing crisis.

Said another way, policies which increase employment, even if they result in less efficient production of consumption goods, will make people happier.