Nonlinear Credit Dynamics, Regime Switches in the Output Gap and Supervisory Shocks

42 Pages Posted: 16 Aug 2019 Last revised: 4 Sep 2019

See all articles by Francesco Simone Lucidi

Francesco Simone Lucidi

Sapienza University of Rome

Willi Semmler

The New School - Department of Economics; Universitaet Bielefeld; IIASA

Date Written: August 13, 2019

Abstract

Over the last two decades the intensity of credit standards’ tightening during economic contractions has exceeded their easing during expansions among euro area banks. This mechanism is fed by the boom-bust cycle of credit that, as much research has shown, is linked to financial instability with large effects on the real economy. We build a small scale nonlinear quadratic (NLQ) model to study how credit feedback can affect the overall adjustment path of the economy towards some steady state, when the central bank solves a finite-horizon decision problem where the policy rate is allowed to also be zero or negative. Then, we estimate local projections for a super- visory shock hitting banks’ credit standards and propose a new external instrument to identify its dynamic causal impact on the real and financial sector. We find that the regime dependence reveals important information to policy makers to implement macroprudential measures.

Keywords: Nonlinear quadratic model, regime switching, local projection, credit cycle

JEL Classification: E37, E44, E58

Suggested Citation

Lucidi, Francesco Simone and Semmler, Willi, Nonlinear Credit Dynamics, Regime Switches in the Output Gap and Supervisory Shocks (August 13, 2019). Available at SSRN: https://ssrn.com/abstract=3433707 or http://dx.doi.org/10.2139/ssrn.3433707

Francesco Simone Lucidi (Contact Author)

Sapienza University of Rome ( email )

Piazzale Aldo Moro, 5
Rome, 00185
Italy

Willi Semmler

The New School - Department of Economics ( email )

65 Fifth Avenue
New York, NY 10003
United States

HOME PAGE: http://www.newschool.edu/nssr/faculty/?id=4e54-6b79-4e41-3d3d

Universitaet Bielefeld ( email )

Universitätsstraße 25
Bielefeld, NRW
Germany

IIASA ( email )

Schlossplatz 1
Laxenburg/Austria, A-2361
Austria

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