What is a Credit Squeeze?

A credit squeeze is a situation that takes place when two economic factors occur at the same time to create a limit on the supply of credit. With a credit squeeze, interest rates increase significantly during a period when lenders are in the process of raising the requirements for obtaining a line of credit. As a result, people with marginal credit ratings are suddenly ineligible to obtain any type of additional credit.

The occurrence of a credit squeeze can have a significant impact on the overall economy. With creditors limiting the supply of credit to consumers, the opportunity for purchasing goods and services with the use of revolving credit is reduced. This in turn can lead to a drop in the value of investments made by the shareholders of companies who supply those goods and services. However, the amount of impact that a credit squeeze can exert on an economy is somewhat limited, since a portion of the consumer base remain eligible to obtain new lines of credit and will continue to purchase new goods and services.

It is important to draw a distinction between a credit squeeze and a credit crunch. With the squeeze, people who are able to meet the tighter requirements for obtaining a line of credit will continue to qualify for loans and other forms of credit. In a credit crunch, access to new credit is so limited that virtually no one qualifies at even the highest of interest rates.

When utilized as a tool to slow down a rate of growth in the economy that is considered dangerous, a temporary credit squeeze can be beneficial. But in situations where the squeeze is not monitored closely, the process of limiting credit opportunities can tip the economy into a situation where there is a money supply contraction. When this happens, the economy will slow at a rate that is not healthy. The end result of this state may include severe drops in the value of securities, failure of businesses, and a national recession that will require an extended amount of time before recovery is achieved.