The term ‘credit crisis’ seems to imply that we can expect a resumption to normal market conditions, and economic growth, as a direct result of increased lending by banks…maybe, but things haven’t worked out that way before.

Much of the recession fighting efforts by central bankers and global political administrations is focused on a forced expansion of credit. In 2007-2008, a ceasing of credit markets was crippling to economic activity. De-leveraging of global markets resulted in a sharp reduction in economic output and a pervasive global recession. The reaction by central bankers was to create conditions where bank-to-bank lending was possible again. To a great extent, and at incredible expense,  this has been accomplished. Indeed in the past few weeks we have seen credit market spreads expand. A positive indicator, since banks are probably using their own capital to lend to clients rather than simply passing on the fire hose of cash flow from the Fed.

While resumption of a normalized credit market is a precondition to ending this recession, the evidence suggests that credit expands only after the economy has rebounded. The effect is to further fuel an already expanding economy. In every recession since 1960 real bank credit didn’t peak until several quarters after the end of each recession. While this time may be different, it is likely that the same economic principles apply today as they have the past 50 years. Banks typically tighten credit as a result of loan losses. This is a reasonable response to limit losses and participate less to the downside of an economic cycle. These normal incentives operate to limit the expansion of credit prior to some clear evidence of economic expansion. When the economy begins to expand lenders expand their efforts to capture the growing market shares. It is unlikely that policy makers will be able to engineer conditions where lenders will lead a meaningful expansion in the economy. At some point incentives should switch in favour of the consumer and creating conditions for expanded demand to replace liquidity concerns as the primary focus of economic leaders.

Here is  a related short essay by Kevin Kliessen, Economist with the  Federal Reserve Bank of St. Louis  http://research.stlouisfed.org/publications/mt/20090301/cover.pdf