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The Role of Credit in Great Moderation: a Multivariate GARCH Approach

  • Grydaki, Maria
  • Bezemer, Dirk J.

During the Great Moderation, financial innovation in the U.S. increased the size and scope of credit flows supporting the growth of wealth. We hypothesize that spending out of wealth came to finance a wider range of GDP components such that it smoothed GDP. Both these trends combined would be consistent with a decrease in the volatility of output. We suggest testable implications in terms of both growth of credit and output and volatility of growth. In a multivariate GARCH framework, we test this view for home mortgages and residential investment. We observe unidirectional causality in variance from total output, residential investment and non-residential output to mortgage lending before, but not during the Great Moderation. These findings are consistent with a role for credit dynamics in explaining the Great Moderation.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 39813.

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Date of creation: 28 Jun 2012
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Handle: RePEc:pra:mprapa:39813
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