Credit-less recoveries: the role of investment-savings imbalances

This paper argues that the investment–savings imbalances of households and companies play an important role in determining the probability that an economy experiences a credit-less recovery, following a recession. The investment¬–savings gap determines the need for “external” finance of the private sector in the form of either bank credit or capital market financing. Using a broad dataset covering 96 countries and 272 recovery episodes, we provide empirical evidence that credit-less recoveries are indeed associated with both low and declining financing needs of the private sector, as proxied by the investment-savings gap at the trough of the recession and its adjustment during the downturn. We show that this reflects a rebalancing of wealth towards financial assets during the downturn which can subsequently be used to finance real investment during the recovery stage, even in the absence of positive bank credit flows. Lastly, we provide empirical evidence that, controlling for the change in investment-savings imbalances, economies whose economic downturn was preceded by a credit boom are more likely to experience a credit-less recovery.