Credit Supply Driven Boom-Bust Cycles

72 Pages Posted: 7 May 2020

See all articles by Yavuz Arslan

Yavuz Arslan

University of Liverpool Management School

Bulent Guler

Indiana University

Burhanettin Kuruscu

University of Toronto - Department of Economics

Date Written: April 3, 2020

Abstract

We study quantitatively how far shifts in the credit supply can generate a boom-bust cycle, similar to the one observed in the US around 2008. For this purpose, we develop a general equilibrium model that combines a rich heterogeneous agent overlapping-generations structure of households who make housing tenure decisions and borrow through long-term mortgages, firms that finance their working capital through short-term loans from banks, and banks whose ability to intermediate funds depends on their capital. Using a calibrated version of this framework, we find that shocks to banks’ leverage can generate sizable boom-bust cycles in the housing market, the banking sector, and the rest of the macro-economy, which provides strong support for the credit supply channel. The deterioration of bank balance sheets during the bust, the existence of highly leveraged households, and the general equilibrium feedback from the credit supply to household labor income significantly amplify the bust. Moreover, mortgage credit growth across the income distribution is consistent with recent findings that were otherwise argued to be against the credit supply channel. Finally, a comparison of the model outcomes across credit supply, house price expectation, and productivity shocks suggests that housing busts accompanied by severe banking crises are more likely to be generated by credit supply shocks.

Keywords: Boom-Bust Cycles, Financial Crisis, Credit Supply Shocks, Household and Bank Balance Sheets, Foreclosures, House Prices, Consumption, and Output

JEL Classification: E21, E44, G21, G51

Suggested Citation

Arslan, Yavuz and Guler, Bulent and Kuruscu, Burhanettin, Credit Supply Driven Boom-Bust Cycles (April 3, 2020). Available at SSRN: https://ssrn.com/abstract=3573994 or http://dx.doi.org/10.2139/ssrn.3573994

Yavuz Arslan (Contact Author)

University of Liverpool Management School ( email )

Bulent Guler

Indiana University

Burhanettin Kuruscu

University of Toronto - Department of Economics ( email )

Toronto, Ontario M5S 3G8
Canada

HOME PAGE: http://https://sites.google.com/site/bkuruscu

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