Credit Crunch Caused Investment Slump

The monetary policy affects the economy through the LM-relation. When money supply changes, the interest rate and aggregate demand also change. The main objective of this paper is to empirically analyze and quantify the effect of changes in the supply of bank credit on private investment. The role of the credit crunch in explaining the collapse in private investment in the early 1990s is also analyzed.

The effect of credit on investment comes through with a lag of about a year and persists for several years. Money supply is a powerful investment predictor in a bivariate relation, but loses its significance completely once credit is included in the model….

Author: Tuomas Saarenheimo

Source: Research Discussion Papers, Bank of Finland

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