The importance of credit demand for business cycle dynamics

Gregor von Schweinitz

No 21/2023, IWH Discussion Papers from Halle Institute for Economic Research (IWH)

Abstract: This paper contributes to a better understanding of the important role that credit demand plays for credit markets and aggregate macroeconomic developments as both a source and transmitter of economic shocks. I am the first to identify a structural credit demand equation together with credit supply, aggregate supply, demand and monetary policy in a Bayesian structural VAR. The model combines informative priors on structural coefficients and multiple external instruments to achieve identification. In order to improve identification of the credit demand shocks, I construct a new granular instrument from regional mortgage origination. I find that credit demand is quite elastic with respect to contemporaneous macro-economic conditions, while credit supply is relatively inelastic. I show that credit supply and demand shocks matter for aggregate fluctuations, albeit at different times: credit demand shocks mostly drove the boom prior to the financial crisis, while credit supply shocks were responsible during and after the crisis itself. In an out-of-sample exercise, I find that the Covid pandemic induced a large expansion of credit demand in 2020Q2, which pushed the US economy towards a sustained recovery and helped to avoid a stagflationary scenario in 2022.

Keywords: Bayesian proxy SVAR; credit demand; credit-driven business cycles; granular instrument (search for similar items in EconPapers)
JEL-codes: C32 E32 E44 G10 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-ban, nep-fdg and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:iwhdps:281058

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