One of the ways in which a financial crisis in Europe can affect America is via credit channels. As I wrote a few weeks ago, European banks provide quite a bit of credit to the U.S. market these days, so if they’re forced to tighten lending that could cause a credit contraction here too.
As the chart on the right shows, it looks like this has already started to happen. But how bad could it get? And what would it mean for the American economy? Via Joe Weisenthal, Jan Hatzius of Goldman Sachs provides some rough numbers:
If [European banks] decided to shrink at the same pace as in the period from 2008Q1 to 2009Q1 — the fastest decline during the global financial crisis — this would imply a decline of just under 25%. If so, the direct hit to US credit growth would be about 0.8 percentage point (that is, 3.3% multiplied by 25%)….How much could a 0.8% drop in credit supply shave off of US GDP growth? [A bit of explanation follows….] This would imply that a retrenchment by Euro area banks could result in a hit of 0.4 percentage point to US growth.
On the bright side, this is a worst case scenario. On the not-so-bright side, this is only one of the channels by which a European recession could affect us. We might not catch pneumonia just because Europe does, but we’re still likely to get a pretty bad cold.