Credit Market Behavior during Turbulent Economic Environments: An Example for a Latin American Country

Abstract

The variability of the economy's growth in Latin American Countries (LACs) tends to far exceed that found in developed nations. Huge recessions are frequent in LACs. Typically, these recessions are accompanied by major exchange-rate-policy breakdowns. In turn, these output and exchange rate changes drastically alter private expectations concerning the future behavior of these variables. As a result, discrete and significant changes in private behavioral functions occur. This typically affects crucial monetary policy indicators, such as interest rates and credit. This turbulent economic environment makes it particularly troublesome for econometricians to test theoretical propositions dealing with credit market behavior, as well as for policymakers to interpret and forecast credit and interest rate behavior. This paper illustrates this issue using Chile as a case study. A simple theoretical model of business credit is developed, which is then used to interpret the developments in Chile's credit market during 1980-1986. Using a partial equilibrium analysis, it is shown how the contemporaneous correlation between output and credit demand can change sign, whenever the economy is subject to unanticipated recessions and devaluations. The analysis is a timely one for policymakers in many LDCs, who are currently on the path of transforming their economies to free-market open-economies.