A Storm Coming?

Here's what people should be thinking about - the New York Federal Reserve did a study in May 2002 called Credit Effects in the Monetary Mechanism. This study examined the effect of changing loan standards or as they put it "do bank lending standards "matter" for the economy—that is, do standards affect loan growth and, more broadly, GDP?....also explore whether credit standards are independent of the monetary policy process or, alternatively, a channel through which policy affects spending and the real economy." They used the Senior loan officer opinion survey for data in this study.

Fed Study

So what does all this mean? Two things - when banks have tougher lending standards does it effect the economy, and second, does it matter what the Fed does to help? The conclusion:

"First, changes in credit standards have a significant effect on both loans and GDP. Second, credit standards appear to be largely independent of the monetary policy process, showing little sensitivity to changes in the Federal Reserve's key policy instrument, the federal funds rate."

They get a little more specific here:

"An unanticipated 10 percent net tightening of standards in the augmented model causes output to fall 0.5 percent at its trough and loans to contract more than 2 percent."

A 10 percent net tightening is not a significant tightening. Using the 2001 recession as an example, net tightening in commercial real estate loans moved 41.2 percent, while net tightening in commercial and industrial loans moved 54.3 percent.

Here's a chart from the study showing the net moves over time.



So when Helicopter Ben says that there is no evidence that the recent credit market turmoil is affecting the economy, he's right because it has only been three weeks since it started. Let's hope the Fed keeps its eye on this measure.