Credit Cycles in the Economy and the Brazilian Case
Credit cycles (or leverage cycles) represent moments in the economy of a country when families and companies get indebted, in order to invest or to spend in different segments, which ends up positively influencing the level of the general economic activity, making the GDP grow. One of the ways to measure the leverage cycle of an economy is by dividing the volume of credit over the GDP. In Brazil we had a very significant leverage cycle between the years 2004-2014. On the Central Bank's website, we see that the level of credit (involving real estate credit, consumer credit, credit cards, vehicle financing, etc.) jumped from 25% in 2002 and 2003 to almost 54% in 2015. This great leverage cycle promoted the growth of the Brazilian economy in this period, becoming its main engine.
However, one of the main problems with credit-driven growth of GDP is that this type of growth tends to be unsustainable in the long run. For, when families and companies find themselves heavily indebted, they begin to deleverage, having to pay off the debts in which they have incurred and causing a cooling off in the economy's cycle of aggregate expansion and investment. After 2014, Brazil experienced a period of deleveraging by families and companies alike, in response to the expansionist cycle of the previous period, influencing the subsequent fall in Brazilian GDP.
As of 2016, we see a lower proportion of credit over GDP, indicating a lower willingness to get indebted on the part of the economic agents. At the same time, when consumption is contracted, entrepreneurs tend to invest less, since part of their installed production capacity starts to become idle. In 2020, we observed a countercyclical movement, substantiated by the increase in bank credit as a response to the COVID-19 pandemic. As a result, in December 2020, the volume of credit over GDP reached once more the level of 54%. Finally, how could all this be applied to the foreign exchange market? Simple, in expansion cycles, it becomes more profitable to invest in variable income, with a tendency for the national currency to appreciate against other pairs.
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