A credit squeeze occurs when
interest rates rise and new credit is difficult to access. At such times, marginal borrowers, or those who have borrowed at the end of any debt-induced asset "bubble", get "squeezed" out of further borrowing, and a contraction in the growth of the money supplyoccurs, triggering a slow-down in the growth of previously inflated assets which have been purchased with leveraged credit (or "debt").
This can result in widespread
foreclosureor bankruptcyfor those investorsand entrepeneurs who came in late to the market, as the prices of previously inflated assets generally drop precipitously at the end of any debt-induced credit cycle.
At any point in the slow growth phase of the credit cycle, this process of "squeezing" or restricting the growth of new credit creation can tip into a severe, uncontrolled money supply contraction. In contrast to a credit squeeze, where borrowing is still possible for borrowers with high
credit ratings, a credit crunchoccurs when new credit (or "debt") is not available at any interest rate—even for those with previously acceptable credit ratings—due to widespread insolvencyin the banking system. At such times, it is the banking system itself that is insolvent and other financial institutions (including overseas financiers) become reluctant to lend to the domestic banking system, resulting in the domestic banking system being unable to issue loans even to credit-worthy borrowers.
Austrian Business Cycle Theory
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