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We no longer hear quite as much about the credit crunch as we did last year. This does not necessarily mean that credit became more easily available to businesses. Another explanation is that firms have changed their behavior regarding borrowing.
We measure the extent of business borrowing by the volume of commercial and industrial loans outstanding, one of AIER's primary lagging indicators of business-cycle conditions. This series consists of the balances outstanding on loans for commercial and industrial purposes held by large domestic banks plus the commercial paper issued by nonfinancial companies. Usually, commercial and industrial loans increase for about six months after the start of a recession, as firms face falling revenues and borrow to finance their operations. In the current recession, however, firms increased borrowing for about 11 months following the start of the recession. This pattern is very similar to that seen in two other deep postwar recessions, which occurred in 1981-82 and 1973-75. Commercial and industrial loans expanded for most of the last year in spite of the claims of frozen credit markets and began falling only this year. What accounts for this pattern? According to the Senior Loan Officer Opinion Survey on Bank Lending Practices, conducted quarterly by the Federal Reserve, most banks saw an increased customer demand for loans in the second half of last year. The primary reason, cited in the survey, was the reduced availability of other forms of financing. At the same time, the banks were tightening their lending standards, primarily due to the less favorable and more uncertain economic outlook. As a result, new loans became more difficult and more expensive to obtain last year, but the firms that already had existing credit arrangements with banks expanded the use of those credit lines to meet their financing needs. According to the most recent Senior Loan Officer Opinion Survey, released in April, the banks are maintaining tight credit standards, still citing the less favorable economic outlook as the primary reason. However, banks also report that the demand for commercial and industrial loans has fallen over the previous three months. The two reasons banks cite as most important are the reduced need on the part of businesses to finance investment in structures and equipment, and the reduced need to finance inventories. The opinion of the bank loan officers is supported by the data. The two charts below compare the trend in investment and the trend in manufacturing and trade inventories in the current recession to the average of these trends in past recessions, and to the trend in the deep recession of 1981-82.  Note: Gross private domestic investment consists of business purchases of new structures, equipment and software and household purchases of new residential real estate. Manufacturing and trade inventories represent the aggregate book value of inventories of materials, goods in process and finished goods stocked by the manufacturing, wholesale and retail sectors of the economy. The average is calculated from the 10 postwar recessions prior to the current one by taking the mean of all comparable months. The plotted lines show the percentage difference (vertical scale) in the series' values for 18 months before and after the peak of the business cycle. July 1981 is the peak that marked the start of 1981-82 recession. (Click on Chart to Enlarge)
The charts illustrate that, approximately a year after the start of the current recession, businesses began to aggressively reduce both their investment in structures and equipment and their inventories. At the same time, and in our view, as a result of this, commercial and industrial loans outstanding began to fall. Evidently, firms began to adjust to the tough economic conditions by cutting their inventories and scaling back their investment plans. Consequently, this allowed them to start reducing their debt levels. These adjustments have set the stage for recovery. When the economy starts to turn around, the firms, free from excess inventories, will be in a better position to increase production. And their reduced debt level will make it easier for firms to engage in the investment projects they have been putting off.
On April 20, 2009 AIER published a detailed comparison of the current recession to the previous ones. This article is available on the Membership Archive free to AIER subscribers or $2 for non-members.
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