Economics
College of Humanities and Social Sciences

The Supply of Credit and U.S. Economic Activity: Empirical Evidence for New Monetary Transmission Mechanisms

Joshua Wojnilower

Major Professor: Thomas Stratmann, PhD, Department of Economics

Committee Members: Carlos D. Ramirez, John W. Verret

Mercatus Center, #4027
April 25, 2017, 01:00 PM to 02:30 PM

Abstract:

The consensus that financial institutions do not independently affect the real economy existed among macroeconomists during the second half of the twentieth century. Changes in the supply of credit were therefore irrelevant to understanding business cycles. The recent U.S. financial crisis, however, put a spotlight on the independent role financial institutions can play in generating and amplifying business cycles. To further explore that role, this dissertation examines empirically if changes in the supply of credit are transmitted to the real economy and, if so, by which mechanisms, during which periods of time, and under what conditions. To the extent that changes in the supply of credit affect economic activity, results shed light on how to implement monetary policy more effectively going forward.

 

Chapter One considers whether a credit supply variable provides consistent and stable information, beyond that of real interest rates and the money supply, about future changes in the output gap during the U.S. post-war era. Results yield evidence that while changes in the supply of credit do provide information about future changes in the output gap, that relationship is neither consistent nor stable. Changes in the supply of credit are, however, the only variable among those considered that offers information about future changes in the output gap during the twenty-first century. 

 

Chapter Two considers whether mechanisms by which changes in the supply of credit are transmitted to the real economy also operated in the U.S. during the Great Depression era. Results provide evidence of an economically significant relationship between changes in the supply of credit, i.e. intermediary “risk appetite,” macro risk premia, and real economic activity during this period. Findings therefore suggest a new explanation for the prolonged non-neutrality of monetary factors, i.e. supply-side credit constraints.

 

Chapter Three considers whether the relationship between the supply of credit and the real economy changed over time and under different credit market conditions during the U.S. post-war era. Results yield evidence that a quantitatively important relationship between the supply of credit and real economic activity exists during the entire era and is not limited to periods of financial stress. Findings, however, also offer evidence that the indirect effect of changes in the supply of credit on real economic activity, operating through their effect on macro risk premia, became quantitatively more important during periods of financial stress in the twenty-first century.

 

The overall conclusion is that mechanisms by which changes in the supply of credit are transmitted to the real economy have operated throughout U.S. history. The economic significance of specific mechanisms, however, shifted over time due to changes in the structure of credit markets and financial institutions. The Federal Reserve may therefore benefit from more permanently expanding its set of indicator variables and monetary policy toolkit.

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