Toward a Unified Framework of Credit Creation

47 Pages Posted: 14 Feb 2014

See all articles by Susanne von der Becke

Susanne von der Becke

ETH Zurich

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute; Southern University of Science and Technology; Tokyo Institute of Technology

Date Written: January 21, 2014

Abstract

We identify the origin of the contradicting perspectives on credit creation offered by Austrian, Mainstream and Post Keynesian economists as the neglect of the primacy of such assets as goods, properties and securities, which always pre-exist any transaction and loan. We develop a unified framework of credit creation based on three leading variables: (i) the amount of collateral assets accepted, (ii) the level of leverage and (iii) the level of trust and confidence. As credit expands along these dimensions, the money supply becomes more endogenous and the financial system more vulnerable to internally generated instabilities manifested as booms and busts. Empirical evidence demonstrates a significant shift in the components of bank balance sheets and a decoupling of bank assets from deposits since the mid-1980s, marking a shift from credit creation within traditional fractional reserve banking to "securitized-fractional reserve banking". Applying our framework of credit creation to the global financial crisis, we argue that growth over recent decades has been increasingly financed by credit creation and that the subprime crisis was both a signature and only one possible trigger in an increasingly unstable financial system. As trust began to recede, so did leverage and the amount of assets accepted as collateral, leading to a contraction in credit and to liquidity spirals. Subsequent measures by policymakers can be interpreted as attempts to avoid further contraction along these three variables.

Keywords: Credit creation, Financial crises, Leverage, Liquidity, Confidence

JEL Classification: B53, E12, E13, E51, G01

Suggested Citation

von der Becke, Susanne and Sornette, Didier, Toward a Unified Framework of Credit Creation (January 21, 2014). Swiss Finance Institute Research Paper No. 14-07, Available at SSRN: https://ssrn.com/abstract=2395272 or http://dx.doi.org/10.2139/ssrn.2395272

Susanne Von der Becke (Contact Author)

ETH Zurich ( email )

D-MTEC
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Switzerland
+41 (0) 44 632 96 56 (Phone)

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

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Southern University of Science and Technology

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Tokyo Institute of Technology

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