Credit demand, credit supply, and the business cycle
Economists often find it hard to identify demand and supply movements in a market separately. This also applies to the case of the market for credit: When aggregate measures of credit are seen to increase during an economic boom, is it then mainly driven by borrowers’ demand for more credit to finance higher levels of consumption and investment, or mainly due to lenders’ increased willingness to supply larger amounts of credit to wealthier borrowers with more profitable projects? If policymakers find that, e.g., credit growth is excessive, it is important to identify the source in order to provide the adequate policy response. An obvious example is the credit growth observed in many developed countries up until the financial crisis of 2007-09. Many posit that this was an important impetus to booming housing markets, and to the severity of the ensuing recession. Few, however, have attempted to disentangle, and quantify, the underlying factors behind such a credit-driven boom-bust cycle in a macroeconomic general-equilibrium framework. Was it supply or demand or some combination? The present project aims at shedding light on this issue.