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# **Box 4. Creditless Recoveries**

**Economic recovery without credit growth is possible.** Several studies looked at the question of ―creditless recoveries‖ and found that such recoveries are not all that uncommon (see Calvo, Izquierdo, and Talvi, 2006; Clasessens, Kose,  and Terrones, 2009; Abiad, Dell‘Ariccia, and Li, 2011; Bijsterbosch and Dahlhaus, 2011). One such study, (Abiad, Dell‘Ariccia, and Li, 2011) analyzed 357 economic downturns in advanced emerging and developing countries to check for the frequency of creditless recoveries, and found that creditless recoveries represent about one-fifth of all recoveries. Although such recoveries are more common in low-income countries and emerging economies, they still represent about 10 percent of all recoveries in advanced economies.

**The likelihood of a creditless recovery is much greater when the preceding recession is accompanied by a systemic banking crisis** (occurring in the two years prior to, or in the year coinciding with, the downturn): three times as high as when there is no banking crisis.<sup>a</sup> Currency crises also increase the likelihood that the recovery will be creditless, as does a downturn that was preceded by a credit boom (the latter doubles the relative frequency of a creditless recovery). Such recoveries are most likely in cases where the downturn is preceded by both a credit boom and a banking crisis (see figure 1). Recent analysis on the countries in CEE (UniCredit 2012) also finds that some of the countries in the region that have been hard hit by large banking shocks and/or experienced a significant deleveraging process have a relatively high probability of seeing a creditless recovery, reflecting supply side or financial sector factors (figure 2).

**Figure 1. Relative Frequency of Recoveries with and Figure 2. Contributions to the Probabilities of without Credit Growth Creditless Recoveries by CEE Regions**

<!-- Start of picture text --> percent<br>100 80<br>Recoveries without credit growth<br>Recoveries with credit growth<br>66.7<br>80<br>60<br>60 contribution of supply factorscontribution of demand factors<br>41.3 estimated probability<br>40 40<br>20 sample avg:<br>20 17.7<br>0 17.3 16.1<br>0<br>Baltics CIS Central Europe SEE<br>Source : Abiad, Dell‘Ariccia, and Li (2011). Source : UniCredit (2012).<br>No Cr boom or banking Cr Credit boom Banking cr.Cr boom & banking cr.<br><!-- End of picture text -->

**Creditless recoveries tend to be weaker and take longer to return to trend growth.** On average, output growth is about a third lower in creditless recoveries than in recoveries accompanied by credit growth, Abiad, Dell‘Ariccia, and Li (2011) found. As a consequence, output tends to be slower to return to trend: within three years from the end of the recession in less than half of the creditless recoveries, compared to over two-thirds of recoveries with credit. A study by McKinsey Global Institute (2010), which analyzed and categorized 32 historical episodes of deleveraging, also found that those deleveraging episodes associated with ―belt tightening‖ (deleveraging in which credit growth lags behind GDP growth) tend, on average, to return to a lower trend growth in the period after deleveraging   (figure 3).

**In principle, weaker growth associated with creditless recoveries reflects subdued demand or supply side factors due to financial market difficulties or imperfections** .<sup>b</sup> Analysis by Abiad, Dell‘Ariccia, and Li (2011) supports the hypothesis that, in general, creditless recoveries are associated with financial market difficulties or supply side problems,<sup>c</sup> and that those components of aggregate demand most dependent on credit (consumption and investment) also contribute to the difference in growth rates between the two types of recovery (figure 4). However, in relative terms, the contribution of investment falls by much more.<sup>d</sup> Similarly, a growth accounting exercise finds that creditless recoveries are associated with lower capital accumulation (consistent with the results of the demand decomposition) and total factor productivity (TFP) growth. The lower TFP growth may reflect the fact that younger start-up firms, which typically have higher productivity growth, find it more difficult to obtain credit during these episodes.