Financial constraints in recession is a demand or supply shock?

Question

In recession, "Are loans lower because of demand or supply?"

This question is bothering me a lot. My thoughts are - We know that money can/is printed by banks so it doesn't seem like it is money supply problem but then my reading from newspapers tells me that it is the banks which stops lending perhaps due to realization that business firms will have a hard time so probability of low profits and therefore stops credit and as a result investment suffers. or Is it the other way round that Investment stops due to low demand hitting its profits and then banks responds to prevent building of Non performing assets?

I am lacking clarity. Kindly, help.

Answer 1

If I remember correctly, financial constraint is the characteristic of the firm and can help analyst ascertain the impact of economy wide financial shock on a specific firm. It is a variable that scholars use to study second order effect. Your question appears to be more in line of whether the financial crisis is a supply shock or a demand shock. This is something which is still open for debate and policymakers regularly cross swords on that. It is an interesting topic of research with scholars defending their side of the turf. Perhaps, you can work on it and see for yourself where your evidences lead you.

Comments

Thank you so much for your thoughts! I'll surely hunt for evidences.