Academic journal article Contemporary Economic Policy

Identifying Credit Crunches

Academic journal article Contemporary Economic Policy

Identifying Credit Crunches

Article excerpt

I. INTRODUCTION

The term "credit crunch" has its roots in the unusually tight credit conditions that existed in the United States in the late summer of 1966, when reports of borrowers unable to obtain credit at any price were common. Before 1966, the postwar United States experienced three periods of tight credit: the spring of 1953, the fall of 1957, and the last third of 1959. These periods were called "credit squeezes" or "credit pinches." Sidney Homer and Henry Kaufman, economists at Salomon Brothers in the 1960s, coined the term "crunch" to describe how the 1966 episode differed from those in the 1950s (Kaufman, 1994).

Since 1966, the United States has experienced several periods of tight credit, some of which have been labeled "credit crunches."(1) This article addresses how economists can identify credit crunches and presents new evidence on the U.S. experiences with tight credit since 1960. It draws new conclusions about which of those experiences are credit crunches.

Definition, of course, determines the methodology for identification. This article defines a "credit crunch" as a period of sharply increased nonprice credit rationing. This definition captures what many economists (e.g., Friedman, 1991; Green and Oh, 1991) and policymakers consider a crunch. Note that the word "sharply" in the definition is critical. Crunches as defined here involve an increase in credit rationing beyond that typical around recessions; they may (but need not) be independent of any change in borrowers' risk profiles.(2)

Given this definition, identifying a credit crunch must involve searching for periods of sharply increased nonprice credit rationing. Ideally, time-series data would be available that quantify the degree of nonprice credit rationing. However, as the Federal Reserve Board (Board of Governors, 1992, p. 2) has pointed out, such data are not available. Instead, only unsystematic survey results and anecdotal evidence exist.

Consequently, a search for credit crunches involves what Romer and Romer (1989) term the "narrative approach": a detailed examination of the historical record from primary sources. This examination first entails identifying all periods that might be crunches - that is, periods in which credit conditions reportedly tightened. Any period considered a "crunch" is investigated further.

The next task is to determine which of the tight-credit periods are crunches. This is done by looking for a preponderance of anecdotal reports by lenders of nonprice credit rationing. The focus on lenders' reports is unique. Traditionally, researchers have considered borrowers' reports, but borrowers have an incentive to complain whenever credit conditions tighten, whether credit has become less affordable or less available. If denied credit, borrowers have little information about lenders' reasons for the denials. Lenders, in contrast, know if they are relying more heavily on nonprice rationing and why. Suppose lenders increase their use of nonprice rationing because exogenous factors - e.g., usury ceilings or credible threats of more stringent regulation - effectively prevent them from rationing by price. Such restrictions on their ability to ration credit reduce their short-run profitability (otherwise more nonprice rationing would be observed in the absence of the exogenous factors). Consequently, lenders would object vocally to these restrictions. In contrast, increased nonprice rationing may represent optimizing behavior by lenders in the absence of an exogenous shock to the credit allocation process. Lenders would have no incentive to complain under these circumstances. In fact, evidence should exist of their defending their lending practices against borrowers' protests. Similarly, tight-credit periods that do not warrant the term "crunch" because they are characterized primarily by increased price rationing also would not generate lender protests.

Finally, because "actions speak louder than words," the focus in examining political economy forces should be on policymakers' actions, not their intentions. …

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