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Credit and the global recovery
There is a wide consensus that a primary cause of the financial crisis was excessive
lending. Too much credit was available to too many borrowers on too easy terms. The
flow of credit was unsustainable, and the crash seems – with hindsight – inevitable.
So now what?
First, it seems obvious that the flow of credit needs to be tightened (either
quantitatively or by a higher price), and indeed this has already happened. Hopefully,
the worst is behind us in the sense that any positive economic growth rate should
make borrowers marginally more creditworthy and lenders marginally less gun-shy,
Bill Cheney
Chief Economist
617-572-9138
bcheney@mfcglobalus.com
Oscar Gonzalez
Economist
617-572-9572
ogonzalez@mfcglobalus.com
economic research
so that the flow of new lending can edge upward rather than continue declining.
Second, however, is the issue of the amount of credit outstanding. One school of thought argues that this was
and still is excessive, and needs to be much lower. If you buy this logic, then there is all sorts of pain still to come
as banks, households and businesses will all be constrained by the process of deleveraging. If small businesses in
particular can’t get new credit lines or roll over their old ones, then the economy could easily face another leg down.
Given the commonly quoted factoid that 10% of American businesses fail each year in normal times, a credit crunch
that limited the growth of both the survivors and the replacements would lead straight back into another recession.
I do not find this story compelling. It’s not obvious that the amount of credit outstanding is or was a meaningful
benchmark of anything, nor does it have any predictive mean-reversion properties. Of course the stock of credit
is related to the flow of new loans, but in no way does the need for a reduced flow of credit logically imply that
the amount outstanding needs to drop by any particular