During periods of commercial banking stress, financial institutions often implement stricter lending criteria. In 2011–2012, commercial banks across the Eurozone sharply reduced their credit supply, which limited the availability of loans for households and businesses. This weakened aggregate demand and contributed to higher unemployment.
Faced with a severe contraction, monetary authorities lowered official policy rates close to the zero lower bound. However, when conventional interest rate cuts proved insufficient to stimulate borrowing due to damaged bank balance sheets, central banks turned to unconventional measures, such as targeted long-term refinancing operations and asset purchase programmes.
Extract E states: ‘...commercial banks across the Eurozone sharply reduced their credit supply, which limited the availability of loans for households and businesses. This weakened aggregate demand and contributed to higher unemployment.’
With the help of a diagram, explain how a reduced availability of credit for households and firms may lead to an increase in unemployment.
327 exam-style questions on AQA A Level Economics 2.3 Economic performance, covering 2.3.1 Economic growth and the economic cycle, 2.3.2 Employment and unemployment, 2.3.3 Inflation and deflation, and 2.3.4 Possible conflicts between macroeconomic policy objectives. Each one has a worked solution and a mark scheme showing where the marks go.