The Role of Credit Supply in the Australian Economy

Historical experience shows that disruptions in credit markets can have a material impact on activity and inflation. However, it is hard to measure such effects owing to the difficulty in isolating credit supply shocks. This paper employs survey data to identify the impact of credit supply shocks in Australia over the past three decades, using a structural vector autoregression approach. We estimate that a one standard deviation shock to the balance of firms reporting difficulty obtaining finance (a 'credit supply shock') reduces Australian GDP by almost ⅓ per cent after one year and gross national expenditure by nearly ½ per cent. The effect on business credit is larger and more persistent, with credit declining by nearly 1 per cent relative to its baseline after two and a half years. During the global financial crisis, the cumulative impact of credit supply shocks is estimated to have contributed to a reduction in GDP of 1 per cent (in mid 2009). While credit supply shocks had a notable effect on GDP during the global financial crisis, this credit event appears to have been shorter and sharper than that experienced during the period of financial instability in the early 1990s. Consistent with a 'credit channel' of monetary policy transmission, an unexpected tightening of monetary policy results in a significant increase in the balance of firms reporting difficulty obtaining finance. We also find effects consistent with a financial accelerator mechanism, whereby an improvement in balance sheets results in easier credit conditions and higher GDP and business credit. Altogether, these results suggest that credit market developments have been an integral aspect of the business cycle in Australia since financial deregulation in the 1980s.