The Political Origin of Credit Cycle

Abstract

We find a decline in government’s popularity predicts a subsequent increase in credit to GDP ratio by investigating a cross-country panel with 22 advanced economies from 1984 to 2016. The result suggests governments may manipulate their supports by actively intervening the credit market. We use U.S. mortgage data provide further evidences of the negative relationship between government popularity and subsequent change in the amount of government-backed loans, a fiscal credit policy tool widely used in U.S. and other advanced countries. We argue that when the shock to government popularity is persistent and the information friction in financial market is important, government will have incentive to smooth the popularity shock by adjusting fiscal credit policies, while if an economy’s dominant financial friction is the barrier of entry, government will turn to the traditional fiscal policies.

Keywords: Political Economy, Credit Cycle, Political Popularity

JEL Classification: D82, E44, P34