Declines in the Credit Multiplier Due to Instability in the Financial System(in Japanese)

1. Purpose of the study The decline in the credit multiplier during the 1990s in Japan is an important factor in explaining the persistent recession during this period. To clarify the cause of the decline in the credit multiplier is also useful in determining the causes of the deflation. In this paper I propose a simple model, in which the nonperforming loan problem in the banking sector causes a decline in the credit multiplier and empirically assess this hypothesis by a VAR analysis. 2. Method In the theoretical portion of the paper, I describe a partial equilibrium model of a simplified banking sector and show that an increase in nonperforming loans reduces the credit multiplier. I also argue the risk of bank failure may cause a decrease in the expected return on bank deposits, which encourages agents in the nonfinancial sector to hold more cash. In the empirical portion, I conduct a vector autoregression analysis for the period from January 1983 to December 2004, using the index of industrial production, the consumer price index, the money supply (M2), the monetary base, the call rate, and the index of bank stock prices. The bank stock prices are used as a proxy for the financial health of the banking sector, since the actual amount of the nonperforming loans is difficult to measure. 3. Main results The VAR shows that the money supply contracts for no less than 35 months in response to a negative shock to bank stock prices. The impulse response of the industrial production behaves similarly. 4. Conclusion It is shown theoretically and empirically that an increase in nonperforming loans or disruptions of bank health may cause a decline in the credit multiplier.