James McAndrews: Credit growth and economic activity after the Great
Recession
Remarks by Mr James McAndrews, Executive Vice President and Director of Research of
the Federal Reserve Bank of New York, at the Economic Press Briefing on Student Loans,
Federal Reserve Bank of New York, New York City, 16 February 2015.
* * *
Accompanying tables and figures can be found at the end of the speech.
Good morning and let me welcome you to our press briefing focusing on developments in the
student loan market. My remarks will concentrate on the role of credit markets more
generally during this economic expansion. As a reminder, these remarks reflect my own
views, and not those of the Federal Reserve Bank of New York or of the Federal Reserve
System.
First, let me say a few words on the current economic outlook. Real GDP grew 2.4 percent
over the course of 2014. As New York Fed President Dudley noted earlier this month,
despite what appears to be a soft first quarter, we expect that real GDP growth will continue
over the next couple of years at a similar rate, supported by solid underlying fundamentals
and accommodative financial conditions. Unemployment should continue to decline and
approach 5 percent by late this year. Because of the recent sharp fall in oil prices and the
appreciation of the dollar, inflation will be very low over the coming months. However, as
these temporary factors dissipate, economic slack declines further and inflation expectations
remain stable, inflation should slowly move up toward the Federal Open Market Committee's
longer-run objective of 2 percent.
Using data from the National Income and Product Accounts, this expansion so far has
exhibited unusual features compared to previous long expansions. Most notably, the pace of
growth during the early years of this expansion was well below that of the early years in
previous long cycles (Table 1). Among the factors for the slower growth were unusually low
contributions from residential investment and from nondurables and services consumption. In
contrast, the contribution from durables consumption, particularly for motor vehicles, was
similar to that observed in previous expansions. Even though real GDP growth has picked up
some in the past two years, these patterns are still evident (Table 2).
The slow growth during the current expansion, what we might call the long shallow recovery,
is likely a result of a confluence of many factors including constrained monetary and fiscal
policies, demographic factors and economic and financial developments abroad.
Today, I'd like to consider developments in credit markets in the context of this shallow
recovery. Credit availability is a crucial ingredient in any advanced economy's recipe for
economic growth because credit can support investment in productive enterprises and can
smooth household spending from fluctuations in income. Credit is the means through which
financial assets accumulated by savers can earn returns by being put to productive uses.
Based on data from the Financial Accounts of the United States (Flow of Funds), real credit
(that is, credit after taking into account the effects of inflation) to both corporations and
households in prior recoveries generally started to grow fairly quickly after the end of the
recession. By contrast, in the most recent recovery the real credit outstanding of businesses
(corporations and non-corporations) declined for about two years after the end of the
recession. And only recently - more than five years after the end of the recession - has it
attained pre-recession levels (Figure 1). More dramatically, real credit to households
continued to decline for about four years and, while it has finally begun to expand, is still well
below its pre-recession levels (Figure 2).
These different patterns of credit growth partly reflect the weak state of the banking sector
following the financial crisis. The U.S. banking sector experienced record losses in the Great
Recession that impaired a significant portion of banks' capital and triggered many failures.
These losses would have been even higher had it not been for the liquidity and solvency
support from the official sector - including the U.S. Treasury, the FDIC and the Federal
Reserve. Sorting banks by the losses incurred during a recession relative to equity capital at
the beginning of the recession, it is clear that the U.S. banking industry across this spectrum
was much more adversely affected in the latest recession than in the two prior recessions
(Figure 3). The legacy of those losses has likely limited the banking sector's ability to extend
new loans during this expansion, as banks acted in a highly precautionary way to accrue
capital that had been depleted as well as to add to their previous capital levels.
The need for banks to repair their balance sheets following the financial crisis contributed to
the far slower growth of outstanding bank loans during this expansion when compared to
previous long expansions. Real outstanding loans to businesses, which are dominated by
bank loans, declined more in this recovery than in previous recoveries (Figure 4). On the
household side, real outstanding residential mortgages, which are largely originated by
banks, have declined through most of this expansion while they grew steadily in previous
expansions (Figure 5). Consumer credit has risen at a modest rate in this recovery -
comparable to that of the last cycle (Figure 6). This category includes auto loans, credit cards
and other consumer debts that are mainly originated by banks. But it also includes student
loans where the federal government is the dominant lender. Student loans have risen
robustly during this expansion, and have driven much of the rise of overall consumer credit.
We will have much more to say about them later in today's briefing.
The U.S. financial system relies more heavily on capital markets than other advanced
economies. Bonds and other negotiable debt instruments are an important source of funding
to credit-worthy corporations. Indeed, the growth rate of real nonfinancial corporate bonds
outstanding during this expansion has been roughly similar to that of previous expansions
(Figure 7). A similar pattern is evident in the commercial paper market (Figure 8).
Notwithstanding the robust performance of debt markets during this expansion, the sharper
decline in outstanding bank loans to businesses that I mentioned earlier was likely a
contributing factor to the slower economic recovery we have observed this time around.
These developments appear to have had adverse consequences on the cost and availability
of credit for bank-dependent borrowers. Also, in the early years of this recovery,
bankdependent firms appear to have deleveraged more and invested less than firms with access
to capital markets. So, the impairment of banks' ability to extend credit still has the potential
to hinder investment and adversely affect the overall economy.
We see similar correlations when it comes to lending to households. The expansion in auto
lending that commenced in 2010 coincided with a recovery in auto sales, which have now
essentially regained the ground they lost during the recession. Until recent quarters, overall
consumption growth has been slow, consistent with a pattern of slow growth in credit card
balances. The most obvious case is mortgages where - after a massive tightening from 2007
to early 2010 - underwriting standards remain very tight. This tightness, especially for
nonprime borrowers, has likely been a factor behind a persistently sluggish housing market that
has held back this recovery relative to earlier ones.
Overall, these patterns of credit growth support the idea that the weakness of banks at the
end of the Great Recession has been a contributing factor to the slow recovery of the U.S.
economy since the recession. These patterns are consistent with evidence provided in the
work of Carmen Reinhardt and Kenneth Rogoff, and in that of Christina and David Romer,
indicating that the severity of recessions and strength of the subsequent recovery are
associated with the amount of financial distress experienced in a financial crisis.1
There is also a strong likelihood that decreased credit demand - for example, from
households whose homes fell in value below what they still owed on the mortgage - also has
played a part in the slow growth of credit in this expansion, as has been expressed in the
work of Atif Mian and Amir Sufi.2 Nevertheless, the patterns that I have reviewed here point
to an adverse impact from a relatively weak banking sector on credit supply. However, it also
suggests that the recent improvement in banks' financial condition should provide support to
credit growth going forward, which in turn would provide support to the economic growth we
project over the medium term.
As I noted earlier, one area where credit has flowed freely is student lending. Of course, an
important factor distinguishing student loans from other forms of household debt is the fact
that banks are far less important players and the federal government is instead the dominant
lender. But this is just one factor that makes student loans unique, and I will now ask my
colleagues to provide some more details on this important and fascinating market.
BIS central bankers' speeches
BIS central bankers' speeches
BIS central bankers' speeches