The terms credit crunch and recession ate two vital and much discussed concept in modern economy. They both connote very negative terms in economic environment. Both credit crunch and recession are interrelated owing to their link with economic crises. In common terms, credit crunch (credit squeeze) is a financial period typified with lack of available credit facilities (inability of banks to facilitate borrowing) to public resulting in severe economic consequences. On the other hand, recession is simply a downturn in economic and financial cycle typified with decline in Gross Domestic Product (GDP) for two or more consecutive quarters. The indicators of recession include surge in stock market volatility, increase in unemployment, and decline in the housing market. Recession involves general slowdown of an economic activity over a period of time with macroeconomic indicators such as gross domestic Product (GDP), employment, investment spending, capacity utilization, household incomes, business profits and inflation experiencing a decline; while bankruptcies and unemployment rate establish and increases.
Credit crunch results in reduction of loans or credit facilities with immediate tightening to an economy and society needs of getting loans from the banks. The reason for credit crunch (otherwise terms as bubbles, financial crises or credit squeeze) are multifactorial in nature. The factors that triggering credit crisis includes ;( 1) increased capital and credit facilities imposed by central banking and financial regulatory bodies, (2) tightening financial regulations on banking activities (3) anticipated instability in financial markets (4) inability of banks to recover huge amounts of money previously lent out. All of the factors create a credit squeeze or financial crises most evident with the lack of funds for lending or increased interest on borrowing not really affordable to most people.
The impact of this credit crisis is quite unpredictable with influence of the overall sow down in economic activities most evident with uncertainties by companies for hiring , job cuts, reduction in hours, closure of firms all of which leads to recession and in a case sever case lead to a depression which is basically a prolonged recession. The philosophy behind credit crunch is actually as a result of the faulty and careless practices of the lenders, such as banks and other investor organizations. This can result to a severe shortage of money and credit facilities that could lead to a prolonged recession, the increase in interest rates, and the reduction in prices of goods or assets in a particular kind of business. However, credit crunch is something associated by a getaway to excellent borrowers or investors as they seek no risk in funds that will makes it hard for companies to borrow because lenders are worried of bankruptcies or defaults that might result in higher rate of interest charges. This however, can result to a prolonged recession in the economy, which will occur as the outcome of shrinking credit supply
DISCUSSION
The next section of the essay attempts to discuss the relationship between credit crunch and recession of using information obtained from experts in the field of economy and case studies in the literature. Credit crunch or financial crisis. According to British Brodcasting Corporation (2007), credit crunch first gained attention with the French bank BNP Paribas. Contrastingly, in 2006, Professor Nouriel Roubin nicknamed "Dr Doom"; a US economist predicted the financial crisis (credit crunch) with down fall of United State economy with a cascading effect of global economy (Roberts, 2009). While the debate on the origin of credit of crunch continues, the undisputable fact is that the topic has became a conversation piece in all discussion setting (home, work, gyms, markets,) making it an issue for debate.
Most literature agree that the first notable effect of the credit crisis was the collapse of Lehman brothers in 2008, an event that triggered many governments into taking unprecedented financial measures to most notably increased government spending, tax breaks, and bail out plans for financial institutions. An article published by Luke (2008) titled "From global credit crunch to global recession: After the thunder, comes the rain" provides explicit information on long term effects of this credit crisis including its global banking crisis and government orchestrated solutions to its large bailout and stimulus plans.
Another effect credit crunch in economic slowdown (recession) is seen with the stock market volatility. In a recent article published by one of the renowned financial experts, Nicholas Bloom an economics professor from Stanford University addressees effect of credit crunch on the huge surge in stock market volatility with resultant uncertainties in the financial institutions and unpredictability with central banks policies and governments all leading to instability in economy( Bloom 2007) In his article, Bloom gives a useful case study of this is seen with the S&P100 US stock market, (known as the index of "financial fear") experienced tremendous jump in stock market volatility since news of subprime mortgage crisis emerged in August 2007 indicate the influence of credit crunch on economic activity. In addition, the worrisome issue is the ever increasing levels of stock market volatility since the news of credit crunch, an indicator of its devastating effects on the economy. The credit crunch effect on stock market volatility similar to the effect observes 70 years ago with the Great depression. Similarly to today's credit crunch, stock market crash triggered the Great Depression a catastrophic financial downturn involving withdrawal of credit lines and freeze on interbank lending (Bloom 2007). Despite attempts by the US central bank at salvaging the problem, the knock on effect was recession with 50% drop in US Gross development profit (GDP) (1929-1933). These similarities between the credit crisis and Great depression suggest inevitability of recession with considerable longer term consequences.
The other consequence of the credit crunch is the cost of uncertainty. The reason for concern over the cost of uncertainty and possible effect on economy involved the lack of decisions by firms on investments and employment. The uncertainty about the effect of credit crisis initiates cuts back on investment and employment, two main drivers of economic growth. The lack of decision making hampers economic activity with knock-on effects on economic productivity and overall growth. The lack of decision also affects consumers spending rationale and purchasing power with preference for essential commodities and avoiding durables like cars, fridges, watches, houses and high tech gadgets. All of this effect point towards a prolonged consequence of credit crunch on the economy.
The effect of stock market volatility and the collapse of US Banking system triggered government orchestrated financial solution otherwise known as bailout package with the intention of warding off recession ( downturn in the economy) by pumping money into the economy, slashing interest rates, created money and bought assets (gilts) from insurers, banks and pension companies, corporate bonds (making it cheaper for companies to borrow on bond markets) and shares from rights issues (for ease of generating capital for on equity markets) . These efforts were aimed at making companies feel richer: thereby less likely to sack workers and also. encourage banks to lend more out (Oxolade 2010) .
Other notable case studies of the government initiatives include that of Citibank. A key example is CitiGroup a beneficiary of an enormous financial bailout package (a $20 billion re-capitalisation, and promise of $306 billion in toxic credit assets in exchange for preference shares published in the New York Times (Kennedy 2008). Another key example is seen strategy adopted by UK (inter-bank lending, short-term credit, part-nationalisation of some bank, and slashing central bank interest rates) with the intention of making credit available to business and the public. The problem of credit crunch is a global one spreading like "wild fire" from Europe to Asia to as far as Australia and New Zealand experiencing panics and crisis in their financial markets and economies in the hope of avoiding the inevitable downturn in economy otherwise known as recession.
. Summary
In summary , the essay aims to claim that credit crunch is simply another recession and nothing else based on the evidence obtianed form expertts. The essay startds off by explicity defining the tow interrelated topics, followed by a histrorical perspective of the origin of credit crunch, the factors contributuing to its and case studies and views of financial experts of the implication of credit cruch on the economy with notable example and concludes with government initiatives devised to combat the economic downturn.
Conclusion
Based on the research obtained thus far on credit crunch, it can be assumed that the existing credit crunch is simply transient phenomenon. This evidence presents justifies accepting the earlier part of the argument that credit crunch is simply just a recession. The question of concern is whether the strategy of pumping money into this economy would be worthwhile in the long term.
