Blackadder’s Lair

The home of many a cunning plan

The Cold Hard Truth About the Credit Freeze

When I was about 3 or 4 I had a rather high fever, and my parents decided that the best way to help it break was to put me in the tub and let me sit for a while. The water was freezing, and I complained to my Mom to turn up the heat. “The water is hot,” she said. At first I didn’t believe her, until she pointed to her hands, which turned red from the heat after being placed in the tub, and to the steam rising from the bath. What felt like cold to me was in fact already quite hot, and it was only because of my abnormally high temperature that it didn’t feel that way.

Could something similar be true of today’s credit markets? Everyone seems to agree that credit was given out too freely over the past few years, and that standards need to be more stringent. But to an overheated market, even this readjustment to normal levels would feel like a freeze.

This question (are credit markets frozen, or do they just feel icy due to credit fever?) has been the subject of a remarkable series of posts on the Marginal Revolution blog. Alex Tabarrok started the ball rolling by linking to a recent working paper by the Federal Reserve Bank of Minneapolis which argues against a freeze. Here is a chart from that paper, which shows the quantity of interbank lending for the recent past (not the rate, mind you, but the volume):

Alex’s co-blogger, Tyler Cowen, responded, offering contrary evidence (or, at least, he thinks it’s contrary). Alex replied, and so it’s gone over the past week, back and forth, back and forth, back and forth. Reading the whole thing has been like watching one of those amazing tennis series, where two pros keeping returning each other’s volleys. I’m not qualified to judge the match, but I’ve found the whole thing fascinating nonetheless (and I can guarantee that it ain’t over yet).

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October 27, 2008 - Posted by | Economics, Economy

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