Flashback: Professors Chari, Christiano, and Kehoe debunk 4 myths

NEW WORK

Last month I pointed readers of this blog to empirical work by Professors Chari, Christiano, and Kehoe (hereafter, CCK). Some commentators claim that new work since then overturns their findings. That commentary is incorrect. To see why, let's review.

CCK found that most investment (they offered a rough figure of 80%) is financed without bank lending. I said the same in my New York Times article. The new study does not dispute this finding, which is absolutely fundamental for understanding how the banking crisis impacts us.

Second, CCK found an increase in bank lending. The new study does not dispute the increase, but notes its composition: bank customers were drawing on previously established credit lines. While the additional evidence provided is quite useful, please remember that I had already suspected as much. More important, this point about composition in no way refutes the fundamental claim that banks are still lending to many types of customers.

PRIOR SUSPICIONS
At the time CCK released their important paper, my take was (read in full here and here):

"Professors Chari, Chrisiano, and Kehoe have now looked a variety of Federal Reserve Bank data. From the data, they conclude:

1. "The claim that disruptions to the banking system necessarily destroy the ability of nonfinancial businesses to borrow from households is highly questionable."
2. The data show no decline in bank lending to nonfinancial business.
3. Nonfinancial business are issuing commercial paper at quite low interest rates.
4. The volume of interbank loans continues to be quite high.

... I am wondering whether (2) is bank-driven or customer-driven." and

"I suspect that much of the loan increases are "passive" -- that is, banks had already committed to customers that they could have access to credit and those customers took full advantage (i.e., it is the bank customers who are hoarding liquidity). Likely that is why deposits increased so much: bank loan customers just turned around and made deposits. Nevertheless, it is notable that banks honored their commitments, and then stand to make an easy profit as their customers receive less interest on the deposits than they pay on the loan." (italics added)

Now more study has reinforced the conjecture I made a month ago: that bank lending increased because of customers' drawing on pre-existing credit lines. Authors of the new study acknowledge that the data do not prove the existence of a credit crunch beyond a small segment of borrowers, but might well be explained by customers' lack of willingness to borrow.

MISGUIDED DEBATE

In any case, my prior analysis implies that the backlash against CCK is misguided. First, the real banking problem (from the perspective of the nonfinancial sector) is with settling the old loans, not making new ones. Second, even if the banks' troubles caused them to lend less, you might not be able to detect this with comparisons between Sept-Oct 2008 and prior months, because banks would have been withholding loans much earlier than Sept 2008.