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‫Welcome back in this short lesson, we shall have a quick understanding of credit cycles.
‫Let's jump in.
‫We've learned business cycles in a previous lesson, which uses GDP as a measure of economic activity.
‫Credit cycles, on the other hand, refer to cyclical fluctuations in interest rates and the availability
‫of loans where the bottom of the cycle is characterized by high interest rates and low availability
‫of loans.
‫And the peak of the cycle characterised by low interest rates and wide availability of loans.
‫Apparently, the two cycles are intertwined.
‫Typically, lenders are more willing to lend and tend to offer lower interest rates during economic
‫expansions and are less willing to lend and require higher interest rates when the economy is contracting.
‫The effect goes the other way as well.
‫When credit is cheap and widely available, asset bubbles can form, particularly in the equity and
‫property market.
‫When credit subsequently tightens and gets more expensive, asset prices plunge and lead to a domino
‫effect of defaults.
‫Research suggests that when the directions of the business cycle coincide with the directions of the
‫credit cycles, economic expansions tend to be stronger and contractions are deeper and longer.
‫However, do be aware that the directions of the two cycles may not always coincide.
‫Research suggests that credit cycles tend to be longer in duration than business cycles.
‫For example, there were two economic cycles for the US economy in the Shewan period marked by the dot
‫com bubble and the global financial crisis.
‫But just one credit cycle within the same period when the expansion in credit coincided with economic
‫expansion after the dot com bubble, the economic expansion was strong.
‫But the subsequent recession was made much deeper and longer as it coincided with the credit tightening
‫cycle.
‫Some investors may study the stage of the credit cycle to guide investment decisions.
‫Firstly, it helps to explain if a boom in real estate prices is a consequence of excessive credit.
‫Secondly, it helps investors assess the likelihood of a recession in many past recessions, long periods
‫of excessive credit that coincide with economic boom tend to result in a recession that was preceded
‫by a tightening of credit.
‫And that's all you need to know about credit cycles.
‫See you at the next lesson.