Dynamic credit convergence in CARD: The spreading of common shocks

Most papers evaluate the synchronization of variables for specific regions and periods through static measures of convergence. We measure convergence as the time-varying connection of countries’ credit with the regional cycle in Central America and Dominican Republic (the CARD region). Our interpretation is that this dynamic measure can capture the diffusion of common shocks across countries in the region. Through a FAVAR model, we evaluate what types of shocks affect convergence. We find that the spreading of common shocks varies according to their characteristics. US negative shocks -by increasing convergence- disseminate more widely and cause more synchronized credit responses across countries than positive US shocks. Contractionary US monetary policy shocks have had a negligible impact on regional credit, but they can explain an important part of the synchronization of credit responses. Our interpretation is that external shocks induce a wider synchronization of banks’ responses across countries when they represent a threat. This is partly explained by the readily available information on those shocks and a more extended implementation of macroprudential policies.