New Research Indicates that Reducing the Cost of Lending Leads to Little Stimulus
NYU Stern Professor Johannes Stroebel and co-authors show that banks are reluctant to lend to credit-restrained households because it’s not profitable.
As the US, the European Central Bank and the Bank of England are looking for ways to spur economic activity, they should be aware of the limitations of credit expansion policies.
The authors used data on 8.5 million US credit card accounts during the Great Recession, when policymakers pursued credit expansion policies to encourage banks to lend more to households and firms, with the expectation that this would increase spending and investment.
Key findings include:
- Households with the lowest FICO scores had the highest willingness to borrow.
- Despite lower-cost capital, banks were reluctant to lend to these potential borrowers.
- The authors estimate that a one percentage point reduction in the costs of funds for banks raises optimal credit limits by only $127 for consumers with low FICO scores.
- A bank’s propensity to lend is negatively correlated with a household’s propensity to borrow (i.e., the more likely a household is to borrow, the less likely a bank is to grant additional credit).
- During the Great Recession, banks conducted credit card lending at a profit-maximizing level.
The article, “Do Banks Pass Through Credit Expansions? The Marginal Profitability of Consumer Lending During the Great Recession,” is currently a National Bureau of Economic Research (NBER) working paper.