Financial Market Drift

Today’s international financial markets play a much greater role in the mind of the general public than they did a few decades ago. However, it is still unclear whether this is a desirable development, or whether it indicates looming risks. It would be preferable if financial markets, as key institutions of capital allocation, could sharpen awareness for economic efficiency. On the other hand, problems could arise if financial markets were to draw too much attention as source of disruption of economic processes. Both of these possibilities reflect the relationship between the financial markets and the real economy that runs through this study – in the first instance as a “supportive” relationship, in the second as a “disruptive” one.

Whenever the relationship between the financial sector and the real economy is put forward as a problem, even if “only” as a matter of relative size, there is a need for an analytical framework to deal with the subject. Only such a theoretical understanding, at least one that is implicit, enables any analysis and subsequent assessment. However, there are no established theories about the relative sizes of the two sectors against which current developments can be measured. The approach taken here is therefore gradual and cautious: from the definitional background (Section 2.1), through long-range empirical studies on the relationship between financial sector and real economy development (Section 2.2), to the presentation of diverse variants of a decounline hvnothesis (Section 2.3).

This chapter aims to describe and analyze the actual development of the financial asset ratio and the financial turnover ratio, i.e. the defining characteristics of the decoupling hypothesis using three concrete examples. So far, the increase in these two ratios or in related ratios — such as the financial asset coefficient and volume of credit to real reference figures — was accepted as given. In this respect, the issue is less an examination of the fact as such, and more an analysis of what has happened. How clearly have these ratios risen, for example, to what precise definitions does this apply, and above all: is it possible to reach any conclusions about the back- ground? If, on the basis of the causal areas highlighted in Section 2.3, the real economy base were to predominate, financial sector expansion would be no more than its somewhat more complicated mirror image. Even in this case, however, it could emerge that the suspected negative conse- quences under the decoupling hypothesis will apply (although this is not discussed in detail until Chapter Four).

As will be indicated frequently, research suffers from a fundamental methodological problem – so far apparently unsolvable – regarding the existence and the nature of decoupling consequences for the financial sector: the joint hypothesis test. The question of whether there are decoupling consequences is measured by whether certain time series of economic indicators can be explained by models that are regarded as the “norm” and which are based on certain rationality and behavioral assumptions. The statements that can be made, however, indicate no more than a certain level of evidence because it cannot be assumed with absolute certainty that the underlying model adequately reflects reality. If a supposed decoupling consequence is identified, all that can be said ultimately is that a certain time series does not conform to the fundamental model.

Any economic policy statement is based on an at least implicit analysis of the problem situation and pursues a possibly multidimensional goal. In this respect, it would be expedient here to keep an eye on these two aspects when making an economic policy analysis and deriving potential policy options from this. The first step involves isolating the practically undisputed evidence on which a large majority of observers are likely to agree (Section 5.1). In case of doubt, we decide what can be viewed as the undisputed core of findings on the decoupling hypothesis.

The stated goal of the present study is to document and classify the debate about the potential decoupling of the financial sector from the real economy, and then to introduce it into the context of established scientific lines of research. In our concluding analysis, we do not want so much to summarize our findings in some “balanced” fashion – which was largely achieved in Section 5.1 – but rather to focus on addressing potential tenable indications of decoupling. Identifying such indications that can be taken seriously demands a certain theoretical grounding, and then above all empirical verification. Ultimately, it is not the theoretical possibility of decoupling which is of interest, but rather the question of whether and to what extent this involves a phenomenon that actually exists.