In the October 2009 round of global publications, the IMF forecast that credit growth would remain at historically low levels in the US in 2010, and that this would constrain economic growth (IMF 2009a, 2009b). Yet a number of observers suggest that after financial crises, GDP growth recovers before credit growth turns positive (Calvo and Loo-Kung 2010, Claessens et al. 2009, Calvo et al. 2006). These “credit-less recoveries” were called “Phoenix Miracles” by Calvo et al. (2006).
Despite the diverging conclusions, both the IMF's concerns about credit constraints on GDP growth and the “Phoenix Miracles” view are based on the same inappropriate comparison between the flow of GDP and the stock of credit.
To the extent that spending is credit-financed, demand in a particular period should be a function of the new borrowing that takes place in that period. Demand (and consequently GDP) is therefore a function of the flow of credit, and growth of GDP should be related to growth in the flow of credit rather than growth in the credit stock. This is argued more formally in our paper (Biggs et al. 2010)1. To clarify, the stock of credit is defined as the total amount of outstanding credit of the non-financial sector and the flow of credit is the amount of net new credit extended out over a certain period. The flow is consequently equal to the change in the stock.
An implication of this argument is that what is required for a recovery in demand growth is that new borrowing rises – it is not necessary that the level of new borrowing (and therefore credit growth) is positive. If the private sector is de-leveraging, then a slowdown in the pace of de-leveraging is sufficient to boost domestic demand growth. A credit-led rebound in domestic demand can occur even while credit growth is negative2.
Revisiting the “Phoenix Miracles”
In Calvo et al. (2006), the flow of GDP is compared to the stock of credit. This yields the chart on the left in Figure 1, which shows that the flow of GDP starts to rise even as the stock of credit continues to fall. This divergence is the proverbial “Phoenix Miracle”. A comparison between the flow of GDP and the flow of credit, however, yields the chart on the right. It is easily seen that the recovery in GDP coincides with the recovery in the flow of credit and that these recoveries are neither credit-less nor miracles.
Figure 1. Credit and economic recoveries around systemic sudden stop crises in emerging markets
Source: Calvo, Izquierdo and Talvi (2006). Notes: The left panel shows the average of GDP and the average credit stock across 22 episodes of systemic sudden stops. The right panel shows the average GDP and the average credit flow across the same 22 episodes. The charts are based on the data of Calvo et al. (2006). t denotes the trough of the respective systemic sudden stop episode.
We also show that the “Phoenix Miracle” phenomenon in OECD countries highlighted on this site by Claessens et al. (2009) is also due to the stock-flow mismatch – the flow of credit rebounded in line with GDP after the “Big Five” OECD banking crises, even if the stock of credit lagged the recovery.
The financial crisis of 2007/2008 and the current recovery
If the flow of GDP is related to the flow of credit, then GDP growth should be related to the growth of the flow of credit. In Biggs et al. (2010) we develop a measure of credit we call the “credit impulse”, which is the change in the flow of credit relative to GDP. We focus on credit to the private sector, and compare this to developments in real private sector demand growth. The credit impulse for the US since 1928 is shown in Figure 2. The correlation between the credit impulse and private demand growth confirms the importance of credit flows to GDP.
Figure 2. US private demand and credit impulse, annual data
Source: US Federal Reserve, BEA, US Bureau of the Census
In a recent column on this site, Calvo and Loo-Kung (2010) asked whether the current US recovery is another example of a Phoenix Miracle. In contrast, the credit impulse argument would suggest that recent developments in domestic demand (and GDP) are exactly what one would anticipate given developments in the flow of credit. Throughout 2008 new borrowing in the US fell sharply (Figure 3). It turned negative in Q4 2008 and continued to fall through the first three quarters of 2009. However, the pace of decline slowed, and as a consequence the credit impulse rebounded. Private sector growth increased in tandem.
Figure 3. US private demand and credit impulse, quarterly data
Source: US Federal Reserve, BEA.
The pace of de-leveraging slowed in Q4 relative to Q3 and, if this trend is maintained, the credit impulse could continue to rise through 2010 even though credit growth remains negative. This is exactly what happened during the Great Depression. Arguably due to a policy interventions by Roosevelt in 1933, credit growth increased from -6.7% in 1993 to -2.1% in 1934 and -0.4% in 1935. Credit growth remained negative but, because the pace of de-leveraging slowed, the flow of credit increased and credit impulse rebounded sharply (Figure 4, chart left). The strong credit impulse in 1934 and 1935 supported real private sector demand growth of 9.3% and 10.1% respectively (chart right), even though credit growth was still negative.
Figure 4. US private demand and credit impulse during the Great Depression
Source: US Federal Reserve, BEA, US Bureau of the Census.
Our point is simple. The flows of domestic demand are correlated with the flows of credit, not the stock of credit. The recoveries that have been dubbed “credit-less” only appear so because the stock of credit is compared to the flow of GDP. If the flow of credit is compared to the flow of GDP, it is evident that the rebound in economic activity is usually matched by a rebound in the flow of credit.
The important implication of this analysis is that after a credit crisis all that is required for a recovery in demand growth is that new borrowing rises – it is not necessary that the level of new borrowing (and therefore credit growth) is positive. This is particularly relevant to the US at present, where the non-financial private sector de-leveraged by more than $600 billion in Q3 2009. If the pace of de-leveraging slows gradually from current levels, the increase in the credit impulse would support private sector demand growth even as debt levels fall.
Biggs, Michael, Thomas Mayer and Andreas Pick (2009), “Credit and Economic Recovery”, DNB Working Paper No. 218, July.
Biggs, Michael, Thomas Mayer and Andreas Pick (2010), “Credit and Economic Recovery: Demystifying Phoenix Miracles”, Working Paper Series.
Calvo, Guillermo, Alejandro Izquierdo, and Ernesto Talvi (2006), “Phoenix miracles in emerging markets: Recovery without credit from systemic financial crises”, American Economic Review, 96(2):405-410
Calvo, Guillermo and Rudy Loo-Kung (2010), “US recovery: A new “Phoenix Miracle”?”, VoxEU.org, 12 April.
Claessens, Stijn, Ayhan Kose and Marco Terrones (2008), “What happens during recessions, crunches and busts?”, CEPR Discussion Paper 7085
Claessens, Stijn, Ayhan Kose and Marco Terrones (2009), “A recovery without credit: Possible but …” VoxEU.org, 22 May 2009
International Monetary Fund (2009a), World Economic Outlook: Sustaining the Recovery, October.
International Monetary Fund (2009b), Global Financial Stability Report: Navigating the Financial Challenges Ahead, October.
1 This can also be shown in the context of a simple Ramsey model (Biggs, Mayer and Pick 2009).
2 Very simplistically, assume investment in year t is It, and the stock of credit at the start of year t is Dt-1. If all investment is credit financed, credit is only used for investment, and no credit is repaid during the year, then It = ΔDt. Consequently, ΔIt = ΔΔDt, and investment growth is equal to the second derivative of credit, rather than the first derivative. Investment growth will be positive if the second derivative of credit turns positive, even if the first derivative is still negative.