Princeton University Library Catalog

Which Takes The Credit, Supply or Demand? Evidence for a Supply-Driven Credit Crunch in 2007-2009

Lewandowski, Eva [Browse]
Senior thesis
Moll, Benjamin [Browse]
Princeton University. Department of Economics [Browse]
Class year:
Summary note:
Though much of the literature regarding the financial crisis of 2007-2009 has attempted to identify the relative roles of credit supply and credit demand among banks lending to firms, few studies have explored these mechanics for consumer loans. I analyze the consumer credit sector to uncover the respective contributions of consumer credit supply and demand in propagating the decline in consumer loans during this period. I use consumer loan denial rates to model supply, and attempt to better isolate credit demand by using consumer credit attitudes. I also use loan application rates to model demand, consistent with existing literature. I find that more favorable consumer credit attitudes positively affect percentage change in consumer debt between 2007 and 2009, but that this effect is small relative to that of the supply factor. Second, I find that, though loan applications are highly correlated with the change in debt, there is significant evidence that this is a case of "demand following supply," as changes in loan supply explain between two-thirds and three-fourths of changes in loan application rates in 2007 and 2009. Holmstrom and Tirole (1997) show that credit demand is also affected by the firm lending channel, or firm balance sheet strength. Thus, I search for evidence of a demand-side "consumer lending channel," or consumer balance sheet strength, that mimics the firm lending channel. I find that weakening consumer balance sheets (higher leverage ratios) are associated with slightly higher consumption, contradicting prevailing theory and empirical evidence. Though these findings relate credit demand to consumption rather than to the change in debt, that those with higher leverage were not more likely to decrease spending provides further support for a supply-driven credit crunch. Thus, while both credit demand and credit supply were at play during the financial crisis, demand was secondary to supply in terms of both timing and importance.