Oct 28

Bryan professors ask: What if household credit expansions hurt small businesses?

Have you noticed the many advertisements promoting home equity lines of credit? Or the myriad of promotions for car loans? Is your mailbox filled with offers for credit cards? For the average consumer, having access to more credit, especially in the economic disruption from COVID-19, may seem like a good thing; but what if all of this credit has an impact on small business credit?

Studying how expansions in household credit affect business credit is precisely what Bryan School Assistant Professors of Economics, Drs. Berrak Bahadir and Matthew Schaffer are researching through the lens of macroeconomics – that is, analyzing decisions made by countries and governments, and the impacts of these decisions.

Unlike large corporations, small businesses rely on loans from banks, as do households. Schaffer explains that if there’s a fixed stock of credit, then an increase in household credit could crowd out business credit. On the other hand, if greater household credit stimulates economic activity and increases real estate prices, this could lead to higher collateral values for businesses, which may make it easier for them to obtain additional credit. Therefore, it is not clear how household credit expansions affect lending to small businesses.

“Until the financial crisis of 2007-2009, macroeconomists didn’t understand how the financial sector and the rest of the economy interacted. Economists wanted to better understand why a financial crisis brought down every other sector. One of the findings from the last decade of economic research shows that beyond a certain point, an increase in household credit can be dangerous. Our project is designed to understand the relationship between household and business credit,” Schaffer said.

Credit to households isn’t bad – up to a point. Most household credit is used for home improvements, a bigger home, a new car, and consumer debt. This can lead to a short-term boom, but then people can become overextended leading to a bust. Businesses use credit to increase the productive capacity of the economy – with higher long-term growth.

“Not all credit is created the same; while household credit finances the demand side of the economy, business credit finances the supply side. This distinction is crucial to understand the effects of household and business credit on the real economy,” Bahadir argues.

Another important finding from the last decade is that rapid growth in household debt is a reliable predictor of a recession.

“To avoid recession, limiting the supply of credit to households could help avoid the big booms that can destabilize things,” Schaffer said.

In the middle stages of the project, their theory allows them to analyze models about restricting household credit. First, they build a closed economy model that allows for the study and comparison of two channels emphasized in the literature: the collateral channel and the crowding-out effect. The first goal is to study the general equilibrium effects on the two channels and analyze their relative strengths.

“So far, the policy implications of our research indicate support for having more restrictive measures on the supply of homeowner credit,” Schaffer said.

Second, they study the effect of an externally driven increase in household credit on small business credit empirically, by investigating the impact of the 1998 liberalization of home equity loans in Texas.

“In Texas, homeowners were not allowed to tap their home equity for a line of credit. With the amendment of a more than 100-year-old policy, in 1998, suddenly homeowners had access to a lot of credit. It was a natural experiment for the consequences of expanding the supply of household credit. There was a flood of home equity loans which lead to a decline in small business loan growth in Texas by roughly 10 percent,” he explained.

Both Bahadir and Schaffer arrived at UNC Greensboro several years ago and they knew they wanted to collaborate on a project. After brainstorming, they created a study that would merge and leverage both of their skill sets and interests.

“Bahadir made contributions in the realm of studying household credit and is one of the first economists to highlight the differential impact of household and business credit; she’s been studying it for over a decade,” Schaffer said.

In their study, she brings the theoretical experience and Schaffer brings empirical evidence from the Texas example. With COVID-19 playing havoc on every aspect of the economy, the results of this study may influence policy decisions related to household and small business credit.

“If indeed household credit expansions hurt small businesses, then policymakers should add this finding to the list of negative effects of household debt,” Bahadir said.