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Whether the Bank of Canada takes a breather or continues to raise its policy rate on Wednesday is really of secondary consideration to the fact that credit contraction is now sweeping the North American economies. Another 25bp increase in the prime lending rate, although unwelcomed by borrowers, is not as consequential as the over decline in credit availability.  Access to bank credit is essential to continued economic expansion.  In a recent article for FT.com, (Monetary contraction), Mohamed El-Erian, argues that:

 “We are on the cusp of a credit contraction that will play out over the next several quarters, probably reaching its apex towards the end of this year or the beginning of next year. It is a phenomenon that, unlike financial contagion, is not easily countered by policies.”

One way to measure credit conditions is to examine the current and expected path of monetary aggregates. Central banks measure monetary aggregates in a series of changes in the growth of the money supply. While there are as many as three different calculations of money supply, the overwhelming trend is continued contraction.  In its broadest terms, money supply amounts to currency in circulation, checkable deposits, money market and savings deposits.

Monetary Aggregates Growth, Canada

Central banks rely heavily on money supply aggregates along side interest rates to guide their policymaking.  Mistakenly, many observers accuse the central bank of “printing money,” that is goosing up the money supply. A central bank can only control the reserves held in the commercial banking system, but not the quantity of money which is generated through our fractional banking system.

Whatever measure of money supply one adopts in Canada, the trend is clearly toward contraction which has been underway for nearly a year. Undoubtably, the central banks observers will continue to focus their attention on interest rates. However, it is vital not to lose sight of El-Erian’s warning that lending restrictions that have yet to reach their peak. More to the point, its these restrictions that ultimately lead to a recession.

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