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Credit cycle

The credit cycle is the expansion and contraction of access to credit over time. Some economists, including Barry Eichengreen, Hyman Minsky, and other Post-Keynesian economists, and some members of the Austrian school, regard credit cycles as the fundamental process driving the business cycle. However, mainstream economists believe that the credit cycle cannot fully explain the phenomenon of business cycles, with long term changes in national savings rates, and fiscal and monetary policy, and related multipliers also being important factors.

During an expansion of credit, asset prices are bid up by those with access to leveraged capital. This asset price inflation can then cause an unsustainable speculative price "bubble" to develop. The upswing in new money creation also increases the money supply for real goods and services, thereby stimulating economic activity and fostering growth in national income and employment.

When buyers' funds are exhausted, an asset price decline can occur in the markets which had benefited from the credit expansion. This can then cause insolvency, bankruptcy, and foreclosure for those borrowers who came late to that market. This, in turn, can threaten the solvency and profitability of the banking system itself, resulting in a general contraction of credit as lenders attempt to protect themselves from losses.

See also