Do Credit Market Shocks affect the Real Economy? Quasi-Experimental Evidence from the Great Recession and ‘Normal’ Economic Times
01 Feb 2020-American Economic Journal: Economic Policy (Cambridge, MA: Department of Economics, Massachusetts Institute of Technology)-Vol. 12, Iss: 1, pp 200-225
TL;DR: In this article, a shift-share style research design is implemented to predict county-level lending shocks using variation in preexisting bank market shares and bank supply shifts, indicating that it is costly to switch lenders.
Abstract: Using comprehensive data on bank lending and establishment-level outcomes from 1997–2010, this paper finds that small business lending is an unimportant determinant of small business and overall economic activity. A shift-share style research design is implemented to predict county-level lending shocks using variation in preexisting bank market shares and bank supply shifts. Counties with negative predicted lending shocks experienced declines in small business loan originations, indicating that it is costly to switch lenders. However, small business loan originations have an economically insignificant and generally statistically insignificant impact on both small firm and overall employment during the Great Recession and normal times.
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TL;DR: The authors decompose aggregate loan movements in Japan for the period 1990 to 2010 into bank, firm, industry, and common shocks, and show that idiosyncratic granular bank-supply shocks explain 30-40 percent of aggregate loan and investment fluctuations.
Abstract: We show that supply-side financial shocks have a large impact on firms' investment We develop a new methodology to separate firm-borrowing shocks from bank-supply shocks using a vast sample of matched bank-firm lending data We decompose aggregate loan movements in Japan for the period 1990 to 2010 into bank, firm, industry, and common shocks The high degree of financial institution concentration means that individual banks are large relative to the size of the economy, which creates a role for granular shocks as in Gabaix (2011) We show that idiosyncratic granular bank-supply shocks explain 30-40 percent of aggregate loan and investment fluctuations
185 citations
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TL;DR: In this article, the authors investigated the effects of an exogenous lending cut by a large German bank on firms and counties, and found that the lending cut affected firms independently of their banking relationships, through lower aggregate demand and agglomeration spillovers in counties exposed to the bank's lending cut.
Abstract: Lending cuts by banks directly affect the firms borrowing from them, but also indirectly depress economic activity in the regions in which they operate. This paper moves beyond firm-level studies by estimating the effects of an exogenous lending cut by a large German bank on firms and counties. I construct an instrument for regional exposure to the lending cut based on a historic, postwar breakup of the bank. I present evidence that the lending cut affected firms independently of their banking relationships, through lower aggregate demand and agglomeration spillovers in counties exposed to the lending cut. Output and employment remained persistently low even after bank lending had normalized. Innovation and productivity fell, consistent with the persistent effects.
141 citations
Cites background from "Do Credit Market Shocks affect the ..."
...On the other hand, Driscoll (2004), Ashcraft (2006), and Greenstone et al. (2014) report no or only small effects....
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TL;DR: In this paper, the authors study credit allocation across firms in developing economies with severe financial frictions and find that credit expansions during recessions can slow down or even reverse the gradual reallocation of resources from low to high productivity firms.
Abstract: We study credit allocation across firms in developing economies with severe financial frictions. We illustrate the effects of financial frictions on credit allocation in a dynamic setting, and find that credit expansions during recessions can slow down or even reverse the gradual reallocation of resources from low to high productivity firms. We test the model empirically using China’s economic stimulus plan introduced in 2008, which triggered an unprecedented policy-driven credit expansion. Using private firm-level data we show that new credit was allocated disproportionately more towards state-owned, low-productivity firms than to privately-owned, high-productivity firms, with significant impact on the real economy.
121 citations
Cites background from "Do Credit Market Shocks affect the ..."
...The supply shifter, instead, depends on bank- 31See, for example, Greenstone et al. (2015) and Chodorow-Reich (2014)....
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...As in Greenstone et al. (2015), let us rewrite the national lending of a given bank as a function of supply and demand shifters: ∆Loansbt = D ω t Q λ bt = (Πp(ΠcD µc ct ) µpΠjD νj jt ) ωQλbt where Dt is a national-level demand shifter and Qbt is a bank-level supply shifter....
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TL;DR: In this article, the effect of a shift-share regression model with randomly generated sectoral shocks on actual labor market outcomes across U.S. Commuting Zones was investigated, and it was shown that regression residuals are correlated across regions with similar sectoral shares, independently of their geographic location.
Abstract: We study inference in shift-share regression designs, such as when a regional outcome is regressed on a weighted average of sectoral shocks, using regional sector shares as weights. We conduct a placebo exercise in which we estimate the effect of a shift-share regressor constructed with randomly generated sectoral shocks on actual labor market outcomes across U.S. Commuting Zones. Tests based on commonly used standard errors with 5\% nominal significance level reject the null of no effect in up to 55\% of the placebo samples. We use a stylized economic model to show that this overrejection problem arises because regression residuals are correlated across regions with similar sectoral shares, independently of their geographic location. We derive novel inference methods that are valid under arbitrary cross-regional correlation in the regression residuals. We show using popular applications of shift-share designs that our methods may lead to substantially wider confidence intervals in practice.
103 citations
TL;DR: In this article, the effects of banks on the real economy were reviewed, focusing primarily on US and European policy interventions that provide quasi-natural experiments with relatively exogenous shocks to bank output.
53 citations
References
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TL;DR: In this article, the authors empirically examined how ties between a firm and its creditors affect the availability and cost of funds to the firm and found that the primary benefit of building close ties with an institutional creditor is that the availability of financing increases.
Abstract: This paper empirically examines how ties between a firm and its creditors affect the availability and cost of funds to the firm. We analyze data collected in a survey of small firms by the Small Business Administration. The primary benefit of building close ties with an institutional creditor is that the availability of financing increases. We find smaller effects on the price of credit. Attempts to widen the circle of relationships by borrowing from multiple lenders increases the price and reduces the availability of credit. In sum, relationships are valuable and appear to operate more through quantities rather than prices.
5,026 citations
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TL;DR: The credit channel theory of monetary policy transmission holds that informational frictions in credit markets worsen during tight money periods and the resulting increase in the external finance premium enhances the effects of monetary policies on the real economy as discussed by the authors.
Abstract: The 'credit channel' theory of monetary policy transmission holds that informational frictions in credit markets worsen during tight- money periods. The resulting increase in the external finance premium--the difference in cost between internal and external funds-- enhances the effects of monetary policy on the real economy. We document the responses of GDP and its components to monetary policy shocks and describe how the credit channel helps explain the facts. We discuss two main components of this mechanism, the balance-sheet channel and the bank lending channel. We argue that forecasting exercises using credit aggregates are not valid tests of this theory.
3,853 citations
TL;DR: The authors summarizes and explains the main events of the liquidity and credit crunch in 2007-08, starting with the trends leading up to the crisis and explaining how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.
Abstract: This paper summarizes and explains the main events of the liquidity and credit crunch in 2007-08. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.
3,033 citations
TL;DR: The credit channel theory of monetary policy transmission holds that informational frictions in credit markets worsen during tight money periods and the resulting increase in the external finance premium enhances the effects of monetary policies on the real economy as discussed by the authors.
Abstract: The 'credit channel' theory of monetary policy transmission holds that informational frictions in credit markets worsen during tight- money periods. The resulting increase in the external finance premium--the difference in cost between internal and external funds-- enhances the effects of monetary policy on the real economy. We document the responses of GDP and its components to monetary policy shocks and describe how the credit channel helps explain the facts. We discuss two main components of this mechanism, the balance-sheet channel and the bank lending channel. We argue that forecasting exercises using credit aggregates are not valid tests of this theory.
2,977 citations
TL;DR: The financial market turmoil in 2007 and 2008 has led to the most severe financial crisis since the Great Depression and threatens to have large repercussions on the real economy as mentioned in this paper The bursting of the housing bubble forced banks to write down several hundred billion dollars in bad loans caused by mortgage delinquencies at the same time the stock market capitalization of the major banks declined by more than twice as much.
Abstract: The financial market turmoil in 2007 and 2008 has led to the most severe financial crisis since the Great Depression and threatens to have large repercussions on the real economy The bursting of the housing bubble forced banks to write down several hundred billion dollars in bad loans caused by mortgage delinquencies At the same time, the stock market capitalization of the major banks declined by more than twice as much While the overall mortgage losses are large on an absolute scale, they are still relatively modest compared to the $8 trillion of US stock market wealth lost between October 2007, when the stock market reached an all-time high, and October 2008 This paper attempts to explain the economic mechanisms that caused losses in the mortgage market to amplify into such large dislocations and turmoil in the financial markets, and describes common economic threads that explain the plethora of market declines, liquidity dry-ups, defaults, and bailouts that occurred after the crisis broke in summer 2007 To understand these threads, it is useful to recall some key factors leading up to the housing bubble The US economy was experiencing a low interest rate environment, both because of large capital inflows from abroad, especially from Asian countries, and because the Federal Reserve had adopted a lax interest rate policy Asian countries bought US securities both to peg the exchange rates at an export-friendly level and to hedge against a depreciation of their own currencies against the dollar, a lesson learned from the Southeast Asian crisis of the late 1990s The Federal Reserve Bank feared a deflationary period after the bursting of the Internet bubble and thus did not counteract the buildup of the housing bubble At the same time, the banking system underwent an important transformation The
2,434 citations