The real origins of boom and bust – By Edward Chancellor

Modern economists do not understand how finance shapes economic activity. They see money as an inert veil draped over the “real” economy. By contrast, in Victorian times the credit cycle was viewed as an essential characteristic of capitalism. Today, it is largely ignored. As a result, we have forgotten the basic law that every credit boom – including China’s current one – contains the seeds of its own demise.

Claudio Borio, director of research at the Bank for International Settlements, is a glorious exception to this rule. More than a decade ago, Mr Borio co-authored a paper pointing out that economic hard landings often followed periods of strong credit growth and house price inflation. His findings were roundly ignored. Last month, Mr Borio put forth another paper in which he reasserts the importance of finance in economics. “It is not possible,” he writes, “to understand business fluctuations, and the corresponding analytical and policy challenges, without understanding the financial cycle.”

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Related paper: The financial cycle and macroeconomics: What have we learnt?