<p>The Credit-to-GDP, say  ratio measures the relative size of the outstanding debt of <em>non-financial private sector</em>, say $D_{p,t}$ with respect to (yearly) Gross Domestic Product, say $Y_t$</p>

<p>$$\text{Credit-to-GDP ratio} =\frac { D_{p,t}}{Y_t}$$</p>

<p>Note that GDP should be measured in <em>nominal</em> terms here, since so is debt. It is a metric related to how much burden WE have placed on our future from our current decisions and activities.</p>

<p>The "Credit-to-GDP" gap is, as the OP notes, "the difference of the Credit-to-GDP ratio from its trend". How do we extract that? </p>

<p>Look for example at the, informative with data and literature, page of the <strong><a href="http://www.bis.org/statistics/c_gaps.htm" rel="nofollow noreferrer">Bank for International Settlements</a></strong>. If you hit the "data" link, you will see that what they do is<br>
a) calculate the Credit-to-GDP ratio (per quarter but always using past-12-months GDP in the denominator), and then decompose the obtained time series by using the <strong><a href="https://en.wikipedia.org/wiki/Hodrick%E2%80%93Prescott_filter" rel="nofollow noreferrer">HP filter</a>.</strong></p>

<p>The Credit-to-GDP <em>gap</em> is what it remains if from the actual "Credit-to-GDP ratio" series we subtract the (non-linear) trend as calculated by the HP filter. One can understand why then this "gap" can be negative: we are currently below the trend. Finally note that the Credit-to-GDP gap is also measured in GDP percentage units. But sometimes it may be reported as <em>percentage deviation from the trend</em> (i.e. "we are 30% above trend" does <em>not</em> mean that we are "30 percentage points of GDP above trend"). So read carefully any source.</p>

<p><strong>The question is: why use the "gap" and not the ratio itself?</strong>  </p>

<p>Because we are accepting that the trend likely reflects a <em>sustainable</em> evolution of the economy over time (sustainable by the very ongoing existence of said economy), while the "gap" reflects short-term tendencies that may not be sustainable and may lead to crises if left unchecked and un-managed. </p>

<p>A higher positive gap means that the private sector borrows at a level that is perhaps "not justified" by the current output-producing abilities of the economy. Banks may tend to experience abnormally high rates of loan defaults etc, which can lead to a banking crisis. </p>

<p>A negative gap supposedly implies that there is a "safe" amount of additional borrowing that could be done currently (for consumption or investment purposes), and we are leaving it "unexploited".  </p>

<p>But never read too much on a single metric, economic systems are too complex.</p>

CC BY-SA 3.0
2017-03-20T14:26:11.860Z
So what would a very negative gap imply?
edupppz
CC BY-SA 3.0
2017-03-20T17:31:46.540Z
@edupppz I added something in the answer.
Alecos Papadopoulos
CC BY-SA 3.0
2017-03-18T17:11:14.137Z
2017-03-20T17:31:12.727Z
2017-03-20T17:31:12.727Z
Alecos Papadopoulos
<p>I have been hearing a lot about this metric in relation to rising fears of a Chinese financial crisis. I am wondering, what exactly does this mean? I am told it refers to the difference between current credit-to-GDP ratios and long-term trends but I don't fully understand what that would mean. What would be a nice little equation for it? I have looked at some charts and I am seeing that the US has a negative Credit-to-GDP gap, how can it be negative? I just want to know what the inputs into calculating that would be so I can understand for myself what these things signify.
Thanks.</p>

<macroeconomics><gdp><credit>
What is the Credit-to-GDP gap exactly?
edupppz
# What is the Credit-to-GDP gap exactly?

(Asked by: username_0 on 2017-03-17)

I have been hearing a lot about this metric in relation to rising fears of a Chinese financial crisis. I am wondering, what exactly does this mean? I am told it refers to the difference between current credit-to-GDP ratios and long-term trends but I don't fully understand what that would mean. What would be a nice little equation for it? I have looked at some charts and I am seeing that the US has a negative Credit-to-GDP gap, how can it be negative? I just want to know what the inputs into calculating that would be so I can understand for myself what these things signify.
Thanks.

**Tags:** macroeconomics, gdp, credit


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## 1 answers

### Answer by username_1 on 2017-03-18. Score: 4 | Accepted answer

The Credit-to-GDP, say ratio measures the relative size of the outstanding debt of *non-financial private sector*, say $D\_{p,t}$ with respect to (yearly) Gross Domestic Product, say $Y\_t$

$$\text{Credit-to-GDP ratio} =\frac { D\_{p,t}}{Y\_t}$$

Note that GDP should be measured in *nominal* terms here, since so is debt. It is a metric related to how much burden WE have placed on our future from our current decisions and activities.

The "Credit-to-GDP" gap is, as the OP notes, "the difference of the Credit-to-GDP ratio from its trend". How do we extract that?

Look for example at the, informative with data and literature, page of the **[Bank for International Settlements](http://www.bis.org/statistics/c_gaps.htm)**. If you hit the "data" link, you will see that what they do is  
a) calculate the Credit-to-GDP ratio (per quarter but always using past-12-months GDP in the denominator), and then decompose the obtained time series by using the **[HP filter](https://en.wikipedia.org/wiki/Hodrick%E2%80%93Prescott_filter).**

The Credit-to-GDP *gap* is what it remains if from the actual "Credit-to-GDP ratio" series we subtract the (non-linear) trend as calculated by the HP filter. One can understand why then this "gap" can be negative: we are currently below the trend. Finally note that the Credit-to-GDP gap is also measured in GDP percentage units. But sometimes it may be reported as *percentage deviation from the trend* (i.e. "we are 30% above trend" does *not* mean that we are "30 percentage points of GDP above trend"). So read carefully any source.

**The question is: why use the "gap" and not the ratio itself?**

Because we are accepting that the trend likely reflects a *sustainable* evolution of the economy over time (sustainable by the very ongoing existence of said economy), while the "gap" reflects short-term tendencies that may not be sustainable and may lead to crises if left unchecked and un-managed.

A higher positive gap means that the private sector borrows at a level that is perhaps "not justified" by the current output-producing abilities of the economy. Banks may tend to experience abnormally high rates of loan defaults etc, which can lead to a banking crisis.

A negative gap supposedly implies that there is a "safe" amount of additional borrowing that could be done currently (for consumption or investment purposes), and we are leaving it "unexploited".

But never read too much on a single metric, economic systems are too complex.

> **Comments:**
> **username_0**: So what would a very negative gap imply?  
> **username_1**: @username_0 I added something in the answer.  

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