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Credit-Market Sentiment and the Business Cycle

David Lopez-Salido (), Jeremy Stein () and Egon Zakrajsek ()

No 21879, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Using U.S. data from 1929 to 2013, we show that elevated credit-market sentiment in year t – 2 is associated with a decline in economic activity in years t and t + 1. Underlying this result is the existence of predictable mean reversion in credit-market conditions. That is, when our sentiment proxies indicate that credit risk is aggressively priced, this tends to be followed by a subsequent widening of credit spreads, and the timing of this widening is, in turn, closely tied to the onset of a contraction in economic activity. Exploring the mechanism, we find that buoyant credit-market sentiment in year t – 2 also forecasts a change in the composition of external finance: net debt issuance falls in year t, while net equity issuance increases, patterns consistent with the reversal in credit-market conditions leading to an inward shift in credit supply. Unlike much of the current literature on the role of financial frictions in macroeconomics, this paper suggests that time-variation in expected returns to credit market investors can be an important driver of economic fluctuations.

JEL-codes: E32 E44 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban and nep-mac
Date: 2016-01
Note: AP CF ME
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Published as David López-Salido & Jeremy C. Stein & Egon Zakrajšek, 2017. "Credit-Market Sentiment and the Business Cycle*," The Quarterly Journal of Economics, vol 132(3), pages 1373-1426.

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Journal Article: Credit-Market Sentiment and the Business Cycle (2017) Downloads
Working Paper: Credit-Market Sentiment and the Business Cycle (2016) Downloads
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