This from the Minneapolis Fed:
Thus, roughly 80 percent of such business borrowing is done outside of the banking system. The claim that disruptions to the banking system necessarily destroy the ability of nonfinancial businesses to borrow from households is highly questionable
There are two ways I can read this quote, one that I agree with and one that I dispute. The first way is that “this isn’t the end of the world” – I agree with this, and I still think that people too closely linked to the financial markets are expecting worse outcomes for the global economy than will actually occur.
However, I think the Minneapolis Fed’s paper overplays it a little and suggests that there is no credit rationing element – only a risk-price element.
If this was the case, then risk has been re-priced, maybe even more appropriately, and industries that have an expected rate of return high enough will still be able to borrow. Although this will lead to a slowdown in economic growth this is not a market failure – and as a result no intervention in financial institutions is really necessary.
However, it is likely that this isn’t the case – according to the numbers in the above quote, a freezing up in the financial sector reduces the credit available to firms by 20%. If firms are liquidity constrained you can bet that this will be a big deal 😛
The “evidence” the paper shows to illustrate no credit rationing is decidedly useful – as any decline in non-financial credit will occur with a lag. The concern in a country like New Zealand is that credit will tighten at the start of 2009 – once banks have run through reserves and called in all there favours. As a result, the possibility of credit rationing does exist.
The difficulty we have in the data at the moment is that we can see the price of futures contracts, but we can’t tell how much of the increase is the result of a change in justifiable expected risk from lending (given new information that has been revealed), and how much is the result of an asymmetric information issue which leads to credit rationing. In six months, once we have the data, we will know – and we can say what central banks did wrong and what they should have done. However, at the moment any such statements are simply conjecture.