Credit Supply Driven Boom-Bust Cycles
CAEPR WORKING PAPER SERIES 2021-005
76 Pages Posted: 30 Oct 2021
Date Written: September 16, 2021
Can shifts in the credit supply generate a boom-bust cycle similar to the one observed in the US around 2008? To answer this question, 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 macroeconomy, 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. 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: Credit Supply, House Prices, Financial Crises, Household and Bank Balance Sheets, Leverage, Foreclosure
JEL Classification: E21, E32, E44, E60, G20, G51
Suggested Citation: Suggested Citation