What is Free Credit?
Free credit is the practice of making it easier to get credit, either by relaxing lending standards or lowering interest rates for borrowing. Loose credit often refers to the policies of a country’s central bank, whether it seeks to increase the money supply through the banking system (loose credit) or to contract it (tight credit).
Loose credit environments can also be called accommodative monetary policy or loose monetary policy.
Key points to remember
- Free credit is the practice of making it easier to get credit, either by relaxing lending standards or lowering interest rates for borrowing.
- Central banks have a number of tools to ease credit, including the manipulation of interest rates.
- In recent years, and lately, in response to the economic impacts of government-mandated shutdowns in 2020, the US Federal Reserve has engaged in an increasingly loose credit policy.
Understanding Loose Credit
Central banks differ on the mechanisms they have to create loose or tight credit environments. Most have a central borrowing rate (such as the federal funds rate or the US bank rate) that affects the largest banks and borrowers first; in turn, they pass on the price changes to their customers. The changes eventually trickle down to the individual consumer via credit card interest rates, mortgage rates, and rates on basic investments like money market funds and certificates of deposit (CD).
Central banks can also ease policy through large-scale asset purchases known as quantitative easing. It involves buying government-backed or other assets and creating huge amounts of new money in the form of bank reserves. It does not directly lower interest rates or ease credit conditions, but floods the banking system with new liquidity in the hope that banks will increase lending.
In modern times, central banks normally ease credit in order to prevent or mitigate a recession and tighten credit as the inflationary effects of previous periods of slack credit ripple through the economy and begin to manifest themselves in rising wages and consumer prices. This puts them in a cycle of monetary and credit policy in reaction to the long-term aftermath of previous policies.
Loose credit in recent years
US markets were considered a loose credit environment between 2001 and 2006—the Federal Reserve lowered the federal funds rate and interest rates fell to their lowest levels in more than 30 years. The Fed then tightened its monetary policy for a few years. Then, in 2008, during the economic crisis, the Fed returned to an accommodating credit policy, lowering the reference rate to 0.25%; it remained at that rate until December 2015, when the Fed raised the rate to 0.5%.
These periods of slack credit were intended to encourage lenders to lend and borrowers to take on more debt. In theory, this should also lead to higher asset prices and spending on goods and services (as newly created money and credit enter the economy).
From 2016 to 2018, the Fed resumed gradually tightening monetary policy in very small increments.
The Fed then began to ease policy again, lowering rates in the second half of 2019 in hopes of averting a recession. On top of that, with the start of the government shutdown of huge swaths of the global economy in 2020, the Fed has launched a new round of extremely loose monetary and credit policies in an attempt to mitigate some of the damage. current economic opportunities and to support new programs authorized under the CARES Act.