Credit Cycles

Credit cycles describe the changing availability and pricing of credit. They describe the growth in the private sector credit, i.e., its availability and usage of loans.

Credit cycles are tied to the real economy. When the economy is strong, lenders are eager to offer credit with good terms. However, in a weak economy, lenders are less willing to provide credit, and they make credit terms unfavorable; This can lead to a drop in asset value, more economic problems, and increased defaults.

Applications of Credit Cycles

Loose private sector credit is considered to have contributed to a number of financial crises, including the 2008-2009 global financial crises.

Business cycles can be amplified because of changes in access to external financing. Consequently, there are linkages between business and credit cycles. Recessions accompanied by financial disruption tend to be longer and deeper, while recoveries combined with rapid credit growth tend to be stronger.

Credit cycles tend to be longer, deeper, and sharper than business cycles. Additionally, the length of credit cycles tends to be longer than that of business cycles.

Consequences for policy

Investors will pay attention to the stage in the credit cycle for the following reasons:

• It helps them comprehend developments in the housing and construction markets.
• It helps them evaluate the extent of business cycle expansions and contractions, especially the extent of a recession if it coincides with the contraction phase of the credit cycle.
• It helps them better predict policymakers’ actions.

Traditional monetary and fiscal policies try to reduce business cycle ups and downs. However, macroprudential stabilization policies are now essential to target financial booms. This is important because studies have shown that sharp increases in credit cycles are closely linked to future banking crises.

Question

Investors will pay attention to the stage in the credit cycle least likely because:

1. It helps them better anticipate policymakers’ actions.
2. Credit cycles tend to be longer, deeper, and sharper than business cycles.
3. It helps them understand developments in the housing and construction markets.

Solution

The correct answer is B.

Investors do not pay attention to the stage in the credit cycle because credit cycles tend to be longer, deeper, and sharper than business cycles. They do so for the following reasons:

• It helps them understand developments in the housing and construction markets.
• It helps them assess the extent of business cycle expansions as well as contractions.
• It helps them better anticipate policymakers’ actions.