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Credit supply driven boom-bust cycles

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  • Yavuz Arslan
  • Bulent Guler
  • Burhan Kuruscu

Abstract

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.

Suggested Citation

  • Yavuz Arslan & Bulent Guler & Burhan Kuruscu, 2020. "Credit supply driven boom-bust cycles," BIS Working Papers 885, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:885
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    More about this item

    Keywords

    credit supply; house prices; financial crises; household and bank balance sheets; leverage; foreclosures; mortgage valuations; consumption; and output;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth

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