Tyler Cowen gets Fisked

What is a credit crunch? At first, I thought when people were using this term they meant credit markets weren’t in equilibrium. There was no market for credit. Then when people started talking about the increasing TED spread — basically the price of very short term loans — I thought they meant a credit crunch was a contraction of credit supply. You know banks were all of a sudden more risk averse and they weren’t extending credit that should be extended.

But then someone said, “hey, volumes of credit are actually increasing!” Basically, if supply is decreasing, we’d expect increasing prices, e.g. an increase in the TED spread, but also decreases in quantities, e.g. lower volumes. If volumes are up and prices are up, this is consistent with increasing demand.

To which Tyler Cowen replies with this weirdness. Basically, he’s saying a credit crunch is an impending decrease in supply (or demand even) for credit. Why is this weird? A commenter on that post explains:

“As for the current financial crisis, my view of the data is that many borrowers have been drawing on their pre-existing lines of credit like crazy, for fear that their chances to borrow may be drying up. “

So, your view of the data is that an increase in the amount of loans and credit available is a sign of a freezing of credit and an unwillingness for banks to lend. This is a very convenient position to take. A reduction of loans and credit is a sign of a credit crunch and an increase in loans and credit is also a sign of a credit crunch. This is like the game of flipping a coin where if you flip heads you win and if you flip tails I lose.

“Even now it remains unclear whether these options will be replenished and of course if they are not that means trouble.”

I see…so, we are not in trouble yet, but because in the future we might possibly have a reduction in loans and credit, that definitely means we are in a credit crunch now.

“It does not necessarily show up in current period credit flow data and in fact it may show up counterintuitively as a spike in borrowing.”

A spike in borrowing also means a spike in lending from the banks. But a credit crunch is where banks are unwilling to lend. Now, with new Orwellian double speak, a credit crunch is when banks are willing to lend to everyone and his brother. Some credit crunch.

“I am puzzled by Alex’a admission that there is a recession; no matter which way you assign the causality, doesn’t that mean credit should be contracting?”

Causality does matter. If borrowers choose not to borrow this is not a credit crunch. A reduction in demand for loans due to a recession would not be considered a credit crunch. The credit crunch would have to originate on the supply side. Banks would have to be unwilling to lend to borrowers for there to be a credit crunch. A reduction in loans and credit is a necessary but not sufficient condition for there to be a credit crunch.

Investments are the most volitile component of national income. When GDP is high, investment goes really high and when GDP is low, investment is really low. We’d expect, if we’re entering a recession, to see investment and thus the demand for credit go down. Its hard to call this normal contraction of demand for credit a credit crunch.

The data aren’t telling us we’re in a credit crunch, given a half-way meaningful definition of the phrase “credit crunch”. In fact, the data are consistent with increases in demand for credit and so increases in investment.