The process of recession the role of credit contraction

One of the major factors which can tip an economy into recession is the credit system. Because so much of the modern North American retail trade is financed through bank lines of credit and credit cards and the large value of lines of credit based upon home ownership the system is prone to a reversal once pessimistic expectations affect credit managers and rating companies. In each case the individual actors the banks, credit card companies and credit reporting agencies are simply as they say doing their jobs.

But if they become overly zealous in denying credit, cutting off the oxygen to the system becomes the inevitable result with all the classic consequences of a major crunch. It must also be remembered that that the bank rate merely fixes the structure of rates to a base. The actual rates charged on lines of credit, bank credit cards and department store cards are much higher. When the bank rate is 4.5 %,   these rates can range as high as 27 % or more in the extreme and best to be avoided case of the department store cards.

But the process of credit contraction can be violent and have devastating consequences for an economy in which the rentiers strive to protect their exposure. The irony is that in seeking to do so they simply set off the chain reaction that can bring the whole house down. Once again we see that reason can breed unreason and uncertainty and risk can lead to overshooting the mark in terms of risk avoidance.

Shortages of liquidity are the very essence of recession. The authorities should strive to avoid interest rate policies that overly contract credit and also bear in mind the relative size of the interest rate burden among the masses of consumers.

Of course, the classical school going back to Hayek and the Austrians presume the system requires a periodic bloodletting of this nature to keep it healthy for the long term. Given the dire consequences, this seems like a retrogression back to a darker era.But a number of contemporary macroeconomists who have built their model of labour market clearing on the premise that unemployment is voluntary and due to inadequate job search or unwillingness to accept the market clearing real wage support policy conclusions that reinforce this dire classical view. Too bad because we and the innocents among us will suffer the dire consequences should a major cleansing befall us