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By Jason Stipp | 09-22-2011 01:00 PM

Kasriel: Economy Needs More Credit

Northern Trust Chief Economist Paul Kasriel makes the case for additional quantitative easing.

Jason Stipp: I'm Jason Stipp for Morningstar. As economic concerns intensify and policymakers debate possible solutions, the Northern Trust Chief Economist Paul Kasriel has an interesting proposition in a recent presentation that we need more quantitative easing. A controversial position. He's here with me to make the case today.

Thanks for joining me, Paul.

Paul Kasriel: My pleasure, Jason.

Stipp: So a lot of ideas have been floated out there about the current economic situation. A lot of folks are focusing on sovereign debt issues, the unemployment rate. People are talking about the consumer. But you made the case in your presentation recently that one solution that could help us has to do with credit, and credit is the thing that we should be focusing on. Why did you arrive at that?

Kasriel: Well from a study of history and a study of the Great Depression, there is a book recently published by Reinhart and Rogoff, and they document that whenever you've had a financial crisis, you've had very sluggish growth afterwards, and they did an excellent job of going back centuries and documenting the data, but they didn't explain the data. I think if you go back and look at the data, especially in the 1930s here and really we had a dress rehearsal for this in the early '90s, you see that contraction in what I call depository institution credit, essentially bank credit, is a factor that really has a big impact on the economic cycle.

We saw really quite severe damage done to our financial sector in this last recession. In fact, in 2008 versus '07, corporate profits for financial institutions contracted by 73%. To put that into perspective, in 1930 it was only 56%. Now fortunately we had a more aggressive Fed this time and that didn't degenerate into another depression. But since that time our banks, S&Ls, and credit unions have not been creating any new credit for the economy, and there is a very high correlation between the behavior of bank credit and the behavior of demand in the economy, and we are again not seeing very strong growth now.

Stipp: So I want to talk to you about demand in a moment, but before we get to that, you argue that we should consider more quantitative easing. Now this was a policy that the Fed followed a couple of times earlier in the recovery. Before we really get to your argument, though, I think that there's not a clear understanding of exactly the mechanism of quantitative easing and how it works and its relationship to that credit. Could you just walk us through that?

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