Feedbacks: Financial Markets and Economic Activity
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Markus Brunnermeier
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Darius Palia
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Karthik Sastry
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Christopher Sims
- American Economic Review (Forthcoming)
Abstract
Is credit expansion a sign of desirable financial deepening or the prelude
to an inevitable bust? We study this question in modern US data
using a structural VAR model of 10 monthly-frequency variables, identified
by heteroskedasticity. Negative reduced-form responses of output
to credit growth are caused by endogenous monetary policy response
to credit expansion shocks. On average, credit and output growth remain
positively associated. “Financial stress” shocks to credit spreads
cause declines in output and credit levels. Neither credit aggregates nor
spreads provide much advance warning of the 2008-9 crisis, but spreads
improve within-crisis forecasts.
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