Fed Survey Confirms Broader Economic Improvement, But Concerns Exist

Information provided by the Federal Reserve Board in its January 2018 release of the Senior Loan Officer Opinion Survey (SLOOS) indicates that lending standards on commercial and industrial (C&I) loans to large and medium-sized firms continue to ease on net. The continued easing in standards on C&I loans increase the stock of loans, which in turns fuels job creation. However, the total number employed relative to the population remains below historical levels.

According to the SLOOS, lending standards on C&I loans for large and middle-market firm, those with annual sales at or above $50 million eased by 10.0 percent on net over the previous 3 months ending in late December/early January. The net easing on C&I loans reflected 15.7 percent of respondents that eased standards, but was offset by the 5.7 percent of senior loan officers that tightened standards over the past quarter.

The importance of these responses is illustrated in the figure above, easier lending standards on net coincide with growth in the stock of C&I loans held at FDIC-insured banks, the largest loan category on bank balance sheets. At the same time, a previous post illustrated how net lending standards on C&I loans, like the history of the yield curve, can foretell a recession approximately one year into the future. The acceleration in net lending standards on C&I loans then confirms the low likelihood of a recession in the near future, but also that the stock of these business loans should continue to grow.

However, the growth in the stock of bank-held C&I loans slowed to annual rate of 1.3 percent in the third quarter of 2017, from 4.5 percent over second quarter. The recent steep rise in interest rates may curtail growth in the very near term. As research has explained, “standards” to refer to any of the various non-price lending terms specified in the typical bank business loan or line of credit: collateral, covenants, loan limits, etc.

Net easing of lending standards on C&I loans corresponded to growth in the stock of bank-held C&I loans. Trends in the stock of bank-held C&I loans are inversely related to the unemployment rate, as the stock of C&I loans rises, the unemployment rate falls and vice versa.

The figure above provides a reason for the inverse connection between trends in the C&I loan stock and the unemployment rate, changes in the stock of C&I loans correspond to changes in employment.
A previous post shows how changes in employment correspond to trends in the unemployment rate. An expansion in the debt-financing of capital expenditures by businesses corresponds to hiring which lowers the unemployment rate. Conversely, a contraction in the amount of debt used to finance capital projects coincides with a decline in the number of jobs and an increase in the unemployment rate.

Job growth has helped lower the unemployment rate and the unemployment rate is low, whether taken historically or relative to its natural rate. However, employment may not be considered “high”. The figure above illustrates the typical inverse relationship between the unemployment rate and the employment-to-population ratio. Since the end of the most recent recession, the unemployment rate has fall back to its historically low level but the employment-to-population ratio remains below previous peaks.

Not only has the employment-to-population ratio not returned to its last peak just prior to the Great Recession, but the peak just prior to the Great Recession is below the high reached just before the 2001 recession. This suggests that more recent recessions have caused a kind of damage to the employment-to-population ratio such that the ratio cannot return to the high prior to the recession, a characteristic not convincingly observed in the unemployment rate over the same period.

This idea, known as hysteresis, is receiving attention from the research community. Originally hysteresis was believed to be a potential feature of the unemployment rate, but it’s role in the employment-to-population ratio is being actively assessed. This matters for housing because it indicates that while the unemployment rate is low and the number of jobs is growing, the number of people with jobs is a smaller portion of the population.



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