Credit markets may have led on the way into the recession, but they are likely to lag on the way out, according to economists with Morgan Stanley.

“Banks, in their lending activities, have rarely ever been leaders in economic or market cycles, but are usually followers. Credit growth can be a powerful accelerator in economic expansions and usually kicks in strongly in later phases of the upswing, but it rarely leads markets or the real economy on the way up,” Morgan Stanley says in a research note. “Put simply, the statement that there can be no recovery or pick-up in asset prices without a prior or coinciding pick-up in bank lending flies in the face of the available evidence.”

The economists rely on research from the IMF, noting, “The most relevant finding in our context is that the episodes of contracting credit usually last longer than the recessions that accompany them. If a recession is associated with a credit crunch, it typically starts 4-5 quarters after the onset of a credit crunch. Thus, credit crunches lead economic recessions. However, recessions in the OECD countries typically end two quarters before their corresponding credit crunch.”

“The empirical evidence is clear: if one is looking for a leading indicator of economic recovery, look at money, not credit. Credit crunches tend to lead recessions, but they lag recoveries,” it concludes.

“Right now, money supply growth is accelerating while credit is slowing. We continue to believe that the acceleration in money supply growth and excess liquidity foreshadows an economic recovery later this year. Eventually, the recovery in economic activity and asset prices, along with on-going balance sheet repair in the banking system would then end the credit crunch and lead to a pick-up in bank lending, in line with the typical sequencing,” it says. “To conclude, if one is waiting until credit growth resumes, one will miss both the pick-up in economic activity and the recovery of asset markets.”

IE