Credit and the US Economy
Credit is an important component of the US economy since it serves as a transaction mechanism between the US and its borrowers, with the borrowing countries repaying the money granted to them with interest. The credit boosts expenditure in the US economy, improving income levels (Knoop, 2008, p. 73). As a result, the gross domestic product (GDP) rises, resulting in quicker productivity development. Credit, as a result, contributes to the expansion of the US economy by increasing its revenue, as well as the formation of debt cycles, which contributes to the stability of the US economy. (Knoop, 2008, p. 75).
The Business Cycle and Credit
The business cycle relates to the volatility of a country’s economic growth, as well as the various periods that economy undergoes. One of the factors that lead to the business cycle is credit, which influences the business cycle in a broad range of ways. First, adverse shocks can result from falling prices of various collateralized assets, which in turn can deteriorate the companies’ balance sheets, thus inhibiting borrowing and subsequent investment (Janda, 2011, p. 24). Additionally, credit can cause various disruptions in the financial sector, thereby inducing the tightening of different collateral constraints that can spread to other sectors such as real estate. For instance, the 2008 credit crunch was the major cause of the recession period between 2008 and 2009 (Janda, 2011, p. 28).
Credit and the US Sub-prime Mortgages
An increase in credit and lending in the context of the U.S. sub-prime mortgages promoted the country's economic growth during the 2000s. However, when banks got over-stretched making them call in loans, the country's financial system became short of liquidity, and that is the reason why the U.S. has given more attention to financial instability theories after the credit crunch (Janda, 2011, p. 26). Besides, malfunctioning credit markets are not mere reflections of a deteriorating real economy but are a key factor contributing to the depression of economic activities. Developing profitable projects expanding investments requires entrepreneurs to tap credit markets as a means of obtaining the necessary resources (Knoop, 2008, p. 79).
Role of Credit Rationing
Credit rationing refers to lenders action of limiting the supply of more credit to borrowers, who need funds, even when the borrowers are willing to offer higher interest rates. In fact, credit rationing forms an example of market failure since the price mechanism used does not create equilibrium in the market (Knoop, 2008, p. 81). In a developed country, credit rationing is conducted to ensure appropriate distribution of the country’s resources without any unnecessary waste. Banks in a developed country make use of credit rationing in controlling lending beyond their monetary bases. Besides, the use of credit rationing in a developed country helps in controlling the prices of goods and services, as well as supply and demand, thereby leading to the availability or continuous supply of products and services within the economy. In a developed country, credit rationing allows for the completion of various projects, thereby leading to the creation of jobs and increase in economic growth (Knoop, 2008, p. 85).
Credit Rationing in Less Developed Countries
On the other hand, in a less developed country, credit rationing results in a significant decline in the supply of funds that are available for various banks to lend. Credit rationing also limits the allocation of money to the loan market, a practice which makes it impossible for less-developed countries to implement multiple projects (Janda, 2011, p. 31). Therefore, in a less developed country, credit rationing forms a potential impediment to economic growth partly due to the relative lack of institutions in less-developed countries that can conduct effective screening of borrowers and partially because the lenders are unwilling to lend money. As a result, credit rationing limits job creation in a less-developed country due to the lack of funds to initiate various business projects (Janda, 2011, p. 34).
References
Janda, K. (2011). Credit Rationing and Public Support of Commercial Credit. SSRN Electronic Journal, (23-37). http://dx.doi.org/10.2139/ssrn.1835070
Knoop, T. (2008). Modern financial macroeconomics. Malden, MA: Blackwell Pub.
