Do Credit Booms Predict U.S. Recessions?

Abstract

This paper investigates the role of bank credit in predicting U.S. recessions since the 1960s in the context of a bivariate probit model. A set of results emerge. First, credit booms are shown to have strong positive effects in predicting declines in the business cycle at horizons ranging from six to nine months. Second, I propose to isolate the effect of credit booms by identifying the contribution of excess bank liquidity alongside a housing factor in the downturn of each cycle. Third, the out-of-sample performance of the model is tested on the most recent credit-driven recession, the Great Recession of 2008. The model performs better than a more parsimonious version where we restrict the effect of credit booms on the business cycle in the system to be zero.

Keywords: Credit growth, factor models, business cycles

JEL Classification: G21, E51, C38