Credit easing is a distinct form of unconventional monetary policy employed by a central bank to directly influence the availability and cost of credit in specific markets or for particular types of borrowers during periods of financial stress. Unlike broader monetary interventions, credit easing targets disruptions in the flow of lending by purchasing targeted assets, aiming to unfreeze credit markets and stimulate economic growth. It is part of the larger financial category of monetary policy, specifically falling under unconventional tools used when traditional interest rate adjustments are insufficient. Credit easing seeks to restore the normal functioning of credit channels by providing liquidity to specific segments of the financial system.
History and Origin
The concept of credit easing gained prominence and widespread application during the 2008 financial crisis, particularly in the United States. Faced with a severe contraction in credit availability and a frozen interbank lending market, the Federal Reserve implemented a range of programs designed to address specific dislocations in credit markets. These measures went beyond simply lowering the federal funds rate, which was already approaching zero. Instead, the central bank focused on the composition of its balance sheet and targeted interventions in areas like mortgage-backed securities and commercial paper. This marked a shift towards actively improving credit conditions for households and businesses rather than solely managing the aggregate quantity of reserves in the banking system. The measures were a direct response to the specific challenges posed by the crisis, which saw a breakdown in the transmission mechanism of conventional monetary policy.
Key Takeaways
- Credit easing involves a central bank actively purchasing specific assets to address credit market dysfunction.
- Its primary goal is to ensure the flow of credit to households and businesses, rather than just increasing overall liquidity.
- Credit easing targets specific segments of the financial system experiencing stress.
- It is typically implemented when traditional monetary policy tools, like adjusting interest rates, are insufficient.
Formula and Calculation
Credit easing does not involve a specific formula or calculation in the way that, for instance, a discounted cash flow analysis would. Instead, its "implementation" is characterized by the size and composition of the central bank's asset purchases. While there isn't a singular numerical output, the scale of credit easing can be measured by the monetary value of the assets purchased and the types of securities targeted. For example, during the 2008 financial crisis, the Federal Reserve purchased large quantities of mortgage-backed securities and agency debt. The direct impact is observed in the narrowing of credit spreads and improved availability of financing in the targeted markets.
Interpreting Credit Easing
Interpreting credit easing involves understanding the specific intent behind a central bank's actions. When a central bank engages in credit easing, it signals that it perceives significant problems in specific credit channels that are impeding broader economic activity. The effectiveness of credit easing is not judged purely by the size of the central bank's balance sheet, but rather by whether it successfully unblocks the flow of credit to segments of the economy that need it. This can manifest as increased lending by commercial banks, lower borrowing costs for consumers and businesses in targeted areas, or a reduction in risk premiums for certain asset classes. Observers would look for signs that specific sectors, such as housing or small business, are regaining access to financing at reasonable rates.
Hypothetical Example
Imagine a scenario where a sudden, unforeseen event causes a severe disruption in the market for auto loans, making it nearly impossible for consumers to get car financing, even those with excellent credit histories. This causes a sharp decline in auto sales, impacting manufacturing and employment. In response, the central bank decides to implement a credit easing program.
It announces that it will begin purchasing auto loan-backed securities directly from banks and other lenders. This provides immediate liquidity to these financial institutions, enabling them to originate new auto loans. As the central bank's purchases stabilize the market, banks become more willing to lend, and the interest rates on auto loans begin to decline. Consumers can once again access financing, leading to a rebound in auto sales and supporting the broader economy. This targeted intervention exemplifies credit easing's focus on a specific credit market segment.
Practical Applications
Credit easing is primarily a tool used by central banks during times of significant financial distress or severe recession. Its practical applications include:
- Stabilizing Mortgage Markets: During the 2008 financial crisis, the Federal Reserve extensively used credit easing by purchasing mortgage-backed securities to lower mortgage rates and support the housing market.
- Supporting Corporate Funding: In response to the COVID-19 pandemic, the Federal Reserve Board implemented programs such as the Primary Market Corporate Credit Facility and the Secondary Market Corporate Credit Facility to ensure credit flows to large employers.2 This helped prevent a widespread collapse in corporate funding.
- Facilitating Small Business Lending: Central banks may establish targeted programs to provide liquidity to banks that lend to small and medium-sized enterprises (SMEs), which often face greater difficulties in accessing credit during downturns.
Limitations and Criticisms
While credit easing can be effective in alleviating specific credit market dysfunctions, it is not without limitations and criticisms. One concern is the potential for the central bank to pick "winners" and "losers" by favoring certain sectors or types of assets over others, potentially distorting market signals. There are also concerns about the moral hazard it might create, where financial institutions become overly reliant on central bank interventions during crises, potentially taking on excessive risk in normal times.
Additionally, the exit strategy from credit easing can be complex. Unwinding large-scale asset purchases without disrupting markets or causing inflation requires careful timing and communication. Some critics of unconventional monetary policies, which include credit easing, suggest that while they might provide short-term economic stimulus, their long-term costs and risks, such as exacerbating economic inequalities or creating asset bubbles, may be substantial and underestimated.1 The CFA Institute has discussed the challenges and implications of relying on such measures.
Credit Easing vs. Quantitative Easing
Credit easing and quantitative easing (QE) are both unconventional monetary policy tools that involve expanding a central bank's balance sheet, but they differ in their primary objectives and the types of assets purchased.
| Feature | Credit Easing | Quantitative Easing |
|---|---|---|
| Primary Focus | Functioning of specific credit markets; flow of credit. | Quantity of bank reserves; aggregate money supply. |
| Assets Purchased | Targeted private sector assets (e.g., corporate bonds, mortgage-backed securities, commercial paper). | Primarily government bonds (Treasury securities) and sometimes other long-term, highly liquid assets. |
| Goal | Improve credit availability and reduce borrowing costs in specific troubled markets. | Lower long-term interest rates and stimulate broader economic activity. |
| Origin | Often arises from credit market dislocations during crises. | Typically employed when short-term interest rates hit the zero lower bound. |
As explained by the Federal Reserve Bank of San Francisco, while both policies expand the central bank's balance sheet, credit easing focuses on the mix of loans and securities held by the central bank to directly address credit flow issues, whereas quantitative easing primarily focuses on the quantity of bank reserves with the composition of assets being secondary.
FAQs
What is the main difference between credit easing and quantitative easing?
The main difference lies in their focus. Credit easing targets specific credit markets and assets to restore the flow of lending where it is impaired. Quantitative easing, on the other hand, broadly aims to increase the overall money supply and lower long-term interest rates by purchasing government bonds.
When does a central bank use credit easing?
A central bank typically uses credit easing during times of severe financial instability or economic crisis when traditional monetary policy tools are insufficient. This occurs when specific segments of the credit markets are frozen, preventing the normal flow of funds to businesses and households.
Does credit easing involve printing money?
No, credit easing does not directly involve printing new physical money. Instead, it involves the central bank purchasing assets from financial institutions, which increases the reserves these institutions hold at the central bank. This aims to increase liquidity and encourage lending, rather than directly injecting cash into the broader economy.
Is credit easing a type of fiscal policy?
No, credit easing is a tool of monetary policy, not fiscal policy. Monetary policy is conducted by a central bank to influence the money supply and credit conditions, while fiscal policy involves government spending and taxation decisions.