Fueling the Flames: The Expansion of Credit

Abstract

Speculative manias gain momentum through the expansion of credit. Most increases in the supply of credit do not lead to a mania, but nearly every mania has been enabled by a rapid growth in the supply of credit to eager borrowers. In the last hundred years, increases in the supply of credit have come in part from banks, in part from new intermediaries and instruments, and in part from cross-border investment flows. Some prescribe the control of money—mostly bank deposits—to prevent a speculative mania. However, this prescription ignores the tendency of new channels of credit and new substitutes for money to develop during a mania. Banks can fund credit with non-deposit liabilities, including by tapping the elastic funding on offer in the international banking market.