By definition, a ‘credit crunch’, also known as a ‘credit squeeze’, ‘financial crunch’ or even ‘credit crisis’, is a reduction in the general availability of loans (credit) or a sudden tightening of the conditions required to obtain a loan from the banks or, more generally, from financial institutions. Consequently, a credit crunch generally involves a reduction in the availability of credit independent of a rise in interest rates. This, in turn, implies that in such situations the relationship between credit availability and interest rates has, perhaps for reasons unknown, changed so that either credit becomes less available at given official interest rates or a clear relationship between interest rates and credit availability vanishes. The latter possibility essentially reflects credit rationing.
Since the onset of the financial crisis more than a year ago, ‘credit crunch’ has been one of the key terms in the popular lexicon. The media keeps opining on the topic almost daily. A credit crunch is one of those rare economic events that have a profound ripple effect on economic agents all over the world, including, and in particular, institutions and policymakers. While policymakers have, understandably, worked and are still working actively to respond to the credit crunch and its aftershocks, economists and researchers are digging deeper to gain a more thorough understanding of key elements that give rise to the phenomenon. The significance for the macroeconomy and the dynamic macroeconomic effects of a credit crunch are relatively well understood, but its genesis is less well understood and much more research is needed to fill the gaps in our knowledge in this respect. Thoughtful policy in this area will flow from a solid grasp of the evolution of the phenomenon and current trends in global financial and capital markets, as well as from an understanding of the factors driving financial innovation and the nature of the new products that result from the innovation process.
It is by no means easy, even through careful and well-conducted empirical analysis, to ascertain the existence of a credit crunch and quantify its contribution to eg the current (globalized) economic recession. Changes in credit market equilibrium are the key here. As a credit crunch is more often than not followed by a recession, one difficulty relates to the problems in disentangling shocks to credit supply from those to credit demand: not only do we believe that the aggregate supply of credit shifts adversely to reduce the availability of credit along the dynamic evolution of a credit-related recession, but also that demand for credit itself falls. Not all problems are empirical, however, and perhaps a reasonable theory would refine the notion that an adverse financial shock initially hits the supply of credit and thereafter, once the incipient macroeconomic effects of the credit crunch are being observed, it is the falling demand for credit that underlies credit market dynamics.
More research is clearly needed in this area and, more generally, on issues related to finance and the macroeconomy. To further this objective, the 10th joint Bank of Finland and CEPR conference, ‘Credit Crunch and the Macroeconomy’, co-organized this time by the Cass School (London), was held in Helsinki on 15–16 October. The conference, lasting for a day and a half, focused on the interrelationships between financial markets, aggregate fluctuations and crises, with the more specific aim of getting a firmer grip on the conditions giving rise to a credit crunch. In addition, the organizers wanted to provide a platform for economists to learn more about and to debate where new and relevant research stands on these issues at the present moment, and to provide further impetus for future research. In addition to the eight papers that were presented and discussed, the conference programme included a panel discussion led by three international experts on the main policy and research implications of the current crisis. This research newsletter provides a short summary of the presentations at the conference. |