Credit Allocation and Macroeconomic Fluctuations

Abstract

We study the relationship between credit expansions, macroeconomic fluctuations, and financial crises using a novel database on the sectoral distribution of private credit for 117 countries starting in 1940. Theory predicts that the sectoral allocation of credit matters for distinguishing between “good” and “bad” credit booms. We test the prediction that lending to households and the non-tradable sector, relative to the tradable sector, contributes to macroeconomic boom-bust cycles by (i) fueling unsustainable demand booms, (ii) increasing financial fragility, and (iii) misallocating resources across sectors. We show that credit to non-tradable sectors, including construction and real estate, is associated with a boom-bust pattern in output, similar to household credit booms. Such lending booms also predict elevated financial crisis risk and productivity slowdowns. In contrast, tradable-sector credit expansions are followed by stable output and productivity growth without a higher risk of a financial crisis. Our findings highlight that what credit is used for is important for understanding macro-financial linkages.