A.T. Aburachis, Ph.D.
Department of Economics and Finance
Gannon University
Erie, PA 16541
The most recent financial crisis can be traced, in part, to the surge in credit intensity which is generated per $1 of GDP growth. It was about $1.50 for decades after 1950, eventually rising in the 1980s and peaking at $3 during the 1990s. The credit machine went into top gear again and by 2007, nearly $4.50 of credit was being generated per $1 of GDP growth. The focus of this paper is on the relationship between total credit growth and the ratio of GDP growth to the output gap. Co-integration is used to test if there is a long-run relationship between credit and GDP growth/output gap, and Granger causality is used to ascertain the lead-lag relationship between credit growth and the GDP growth/output gap. This is followed by ascertaining the short-run, that is, the cyclical relationship between credit growth and GDP/output gap as measured by the National Bureau of Economic Research’s designated cycles. Section one discusses the role of credit in the economy, while section two discusses the statistical relationship between credit growth and GDP/output gap. Section three discusses the empirical results, and section four is a conclusion.
Section I
Credit is, of course, vital to any economy, enabling households and firms to make choices about whether to spend now or delay for a future time. There are conditions in which it would play no active role, passively reflecting cyclical fluctuations in output, employment and inflation. In a world of more or less complete transparency between borrowers and lenders, very low transaction costs, and very low risk aversion, access to credit would not be rationed; and ex ante yields on financial assets, including loans and bonds, would not embody risk premium. So if households and firms wanted to bring forward spending in the face of shocks to the economy, they would be able to do so restricted only by their need to remain solvent.