Title: Credit market sentiments as driving force of economic fluctuations
Authors: Maximilian Boeck - Vienna University of Economics and Business (Austria) [presenting]
Abstract: The role of credit market sentiments and investor beliefs on credit cycle dynamics and their propagation to business cycle fluctuations are investigated. Building strongly on recent theoretical contributions that introduce `animal spirits' or credit market sentiments as driving force of cyclicality and instability in the financial market. Those sentiments can be characterised by extrapolation of past credit market outcomes and exhibit a mean-reverting behaviour. We model the Euro area credit and real economy within a Bayesian vector autoregressive framework, where non-linearities are introduced to the model allowing for transitions between an `optimistic' and `pessimistic' regime. Using data from the Bank Lending Survey of the European Central Bank allows to capture forward-looking credit market sentiments, which govern the transitional dynamics between the regimes. A flexible Bayesian approach permits fully probabilistic inference and provides regime probabilities that the credit market behaviour is `optimistic' or `pessimistic'. Moreover, due to the high dimensionality of the proposed model the Normal-Gamma shrinkage prior is applied in order to get more precise estimates. Furthermore, this framework is suited for investigating the impact of accommodative monetary policy in both regimes of the credit cycle by means of structural impulse response analysis.