Abstract

The recovery from the global crisis that erupted in 2007 shows that the decoupling between real and financial variables during the business cycle can lead to negative and long-lasting consequences for the economy. A key feature of the past global crisis in many countries is that the recovery in aggregate output has not been accompanied by a contemporary pick-up in lending flows to the private sector, rendering the recovery credit-less. This paper uses data on output and credit to study the relative roles of demand and supply drivers of credit growth during economic recoveries on a sample of advanced and emerging countries between 1980 and 2014. Using a simple endowment economy model, the paper shows that credit-less recoveries are correlated with liquidity shocks in real and financial markets and with the pace of private sector deleveraging. The empirical analysis shows that during these episodes demand-side frictions played a relatively larger role in predicting the occurrence of the episodes, reflecting weak demand for liquidity by the private sector in the aftermath of the crisis.

Highlights

  • There is a unanimous consensus among economists on the central role played by bank lending in supporting economic activity, especially in the aftermath of severe economic downturns

  • We argue that during these episodes the evidence points to the prevalence of demand-side frictions to credit growth, re‡ected in lower demand for liquidity by the private sector in the aftermath of recessions

  • While existing literature predominantly focuses on the macroeconomic conditions preceding credit-less recoveries, our analysis focuses on the study of demand and supply dynamics underlying credit patterns during crisis episodes, using priceoutput correlations to disentangle the relative contributions of distinct frictions during the recession phase

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Summary

Introduction

There is a unanimous consensus among economists on the central role played by bank lending in supporting economic activity, especially in the aftermath of severe economic downturns. It is among the ...rst works to provide a comprehensive theoretical framework to analyze credit-less recoveries, which places major emphasis on the role of demand and supply side frictions in credit markets to explain liquidity dynamics during the recovery phase of the cycle It employs a novel panel database of crisis episodes between 1980 and 2014 - including data covering the global ...nancial crisis - to examine the relative contributions of demand and supply drivers of credit growth. By analyzing distinct drivers of output recovery, our work shows that subdued lending activity in the aftermath of recessionary episodes, re‡ects (on average) weak demand for liquidity by the private sector These results suggest that when constraints to credit growth are mainly demand-driven, policy interventions aimed at stimulating aggregate demand making full usage of the ...scal and monetary levers should be prioritized. The household receives its nominal endowment income, ptyt, which cannot be spent until the following period

Households
Credit Growth and the Aggregate Economy during Recessions
Testable Implications
Liquidity Shocks and the Shape of The Recovery
Explanatory Variables
Main results
Robustness
Findings
Conclusions
Full Text
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