Title: Nonlinear credit dynamics, regime switches in the output gap and credit shocks evaluated through local projections
Authors: Francesco Simone Lucidi - Sapienza University (Italy) [presenting]
Willi Semmler - New School for Social Research (United States)
Abstract: As much research has recently shown, credit cycles are linked to financial instability with large effects on the real economy. On the other hand, central banks tried to stimulate the economy with credit policies. Empirically, in several euro area countries, one can observe an inverse long-run relation of credit spreads and the output gap - credit spread falling with a positive output gap and rising with a negative output gap. We build a small scale nonlinear quadratic model (NLQ) to study how credit flows and credit spreads are linked to the two regimes of the output gap. Then, we empirically estimate the impulse responses for an exogenous credit supply shock through local projections and propose a new external instrument to identify the dynamic causal effects of the structural shock. The theoretical model demonstrates that credit dynamics may lead the system to a new regime, allowing for expansions but also triggering instability through sudden jumps in credit spreads. In the empirical part, we allow dynamic multipliers to smoothly pass from periods of sustained growth to periods of deep recession so to catch empirically the nonlinear features of the theoretical model. We find that credit supply shocks have a significant impact on real activities, credit spreads, stock prices and house prices. Furthermore, the revealed regime dependence of such effects may provide further information to monetary authorities in setting credit-oriented policies.