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A Chicken And Egg Problem: Do Loans Drive Growth?

...or does economic growth increase demand for loans?

This question is kind of a hobbyhorse of my colleague John Judis, and it's pretty important when you're figuring out how much time/resources to invest in reviving the banking sector versus directly stimulating the economy.

Anyway, this Journal item suggests the answer is pretty murky:

While cash levels on bank balance sheets have nearly tripled from a year ago, loan growth has declined in each of the past three weeks, according to Fed data. That suggests banks still aren't ready to lend, their customers aren't interested in borrowing, or some combination.

Amid a recession, cost-conscious companies are often loath to add debt to their balance sheet. That is a reason loan growth at the nation's commercial banks tends not to rebound until several months after recessions hit their trough. As of February 2009, growth in loans and leases was rising at a 2.86% annual rate, the slowest rate of growth since September 2002. ...

The 2000-01 recession officially ended in November 2001, according to the National Bureau of Economic Research, but the growth rate in loans didn't bottom out until March 2002. The previous recession ended in March 1991, but loan growth didn't bottom until July 1992.

Loans can fuel economic activity, but it takes a certain level of economic activity to fuel demand for loans. When companies are ready to expand payrolls, and "if production stabilizes, the need for financing grows," says Tony Crescenzi, chief bond market strategist at Miller Tabak.

Of course, whatever your feelings about credit growth, credit contraction will almost certainly doom your economy, by dragging down perfectly viable businesses and killing consumer spending. So it's not as if you can just let your banking sector collapse while you approve a big fiscal stimulus bill.

--Noam Scheiber