Credit-Market Sentiment and the Business Cycle

By D. López-Salido, Jeremy C. Stein, Egon Zakraǰsek. 2017

307 citations recorded by the source corpus.

Using U.S. data from 1929 to 2015, we show that elevated credit-market sentiment in year t − 2 is associated with a decline in economic activity in years t and t + 1. Underlying this result is the existence of predictable mean reversion in credit-market conditions. When credit risk is aggressively priced, spreads subsequently widen. The timing of this widening is, in turn, closely tied to the onset of a contraction in economic activity. Exploring the mechanism, we find that buoyant credit-market sentiment in year t − 2 also forecasts a change in the composition of external finance: net debt issuance falls in year t, while net equity issuance increases, consistent with the reversal in credit-market conditions leading to an inward shift in credit supply. Unlike much of the current literature on the role of financial frictions in macroeconomics, this article suggests that investor sentiment in credit markets can be an important driver of economic fluctuations.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/4755013d6ca585fe39cb355b5fe69c645b26690a

Citations in the corpus

Predictable Financial Crises (2020, unknown): “…Crises 865 in a given sector signals an outward shift in the supply of credit, which sows the seeds of its own destruction (Borio and Drehmann (2009), Greenwood and Hanson (2013), Jordà, Schularick, and Taylor (2015), Baron and Xiong (2017), López-Salido, Stein, and Zakrajšek (2017), Kirti (2020)).”
How Does Credit Supply Expansion Affect the Real Economy? The Productive Capacity and Household Demand Channels (2020, unknown): “The top panel in Figure 1 shows that credit to GDP expanded by 21.8 percentage points between 1See for example, Reinhart and Rogoff (2009), Jordà et al. (2013), Krishnamurthy and Muir (2017), Mian et al. (2017), Baron and Xiong (2017), and López-Salido et al. (2017).”
The Term Structure of Growth-at-Risk (2018, unknown): “Lopez-Salido, Stein, and Zakrajsek (2017) show that periods of narrow risk spreads for corporate bonds and high issuance of lower-rated bonds are useful predictors of negative investor returns in the subsequent two years.”