What Is Loose Credit?
Loose credit is the practice of making credit easier to acquire, either through relaxed lending criteria or by lowering interest rates for borrowing. Loose credit often refers to the policies of a country's central bank—whether it is looking to expand the money supply through the banking system (loose credit) or contract it (tight credit).
Loose credit environments may also be called accommodative monetary policy or loose monetary policy.
- Loose credit is the practice of making credit easier to acquire, either through relaxed lending criteria or by lowering interest rates for borrowing.
- Central banks have a number of tools available to loosen credit, including manipulating interest rates.
- In recent years—and in response to the economic impacts of the government-imposed shutdowns due to Covid-19—the U.S. Federal Reserve has engaged in increasingly loose credit policy in recent years.
Understanding Loose Credit
Central banks differ on the mechanisms they have at their disposal to create loose or tight credit environments. Most have a central borrowing rate (such as the Fed funds rate or discount rate in the U.S.) that affects the largest banks and borrowers first; they, in turn, pass the rate changes along to their customers. The changes eventually work their way down to the individual consumer via credit card interest rates, mortgage loan rates, and rates on basic investments like money market funds and certificates of deposit (CDs).
Central banks can also loosen policy through large scale asset purchases known as quantitative easing. This involves purchasing government backed or other assets and creating massive quantities of new money in the form of bank reserves. It does not directly lower interest rates or loosen credit conditions, but floods the banking system with new liquidity in the hopes that banks will increase lending.
In modern times, central banks normally loosen credit in order to prevent or mitigate a recession and tighten credit when the inflationary effects of previous periods of loose credit work their way through the economy and start to show up in rising wages and consumer prices. This puts them into a cycle of setting money and credit policy in reaction to the long term after effects of previous policy moves.
History of Loose Credit in the United States
The U.S. markets were considered a loose credit environment between 2001 and 2006—the Federal Reserve lowered the Fed funds rate and interest rates reached their lowest levels in more than 30 years. The Fed then tightened monetary policy for a few years. Then, in 2008, during the economic crisis, the Fed reverted to loose credit policy, lowering the benchmark rate to 0.25%; it remained at this rate until December 2015, when the Fed raised the rate to 0.5%.
These periods of loose credit were intended to encourage lenders to lend and borrowers to take on more debt. In theory, this should also lead to increased asset prices and spending on goods and services (as the newly created money and credit enters the economy).
From 2016 to 2018, the Fed began gradually tightening monetary policy again in very small increments. However, this led to a severe reaction from asset markets that have become entirely dependent on these loose credit policies; the stock market dropped sharply, home price appreciation stalled, and the Treasury yield curve flattened and then inverted in mid-2019.
The Fed then began loosening policy again, dropping rates through the second half of 2019 in the hopes of avoiding a recession. On top of this, with the onset of the Covid-19 related government shutdown of huge parts of the world economy, the Fed kicked off a new round of extremely loose money and credit policy in an attempt to buffer some of the ongoing economic damage and support the new programs authorized under the CARES Act.