The role of credit in the Great Moderation: A multivariate GARCH approach

Abstract

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.

Financial fragility in the Great Moderation

“…The literature indicates that especially debt-financed returns may increase financial fragility. Grydaki and Bezemer (2013) show that growth in credit supporting wealth formation helps explain reduced output growth volatility. Kemme and Roy (2012) find that the U.S.…”

Análisis de la innovación financiera como un proceso generador de ingresos en las cooperativas de ahorro y crédito del segmento 1 de la provincia de Chimborazo.

“…Acorde al Banco Central Europeo la innovación financiera es una metamorfosis organizacional que admite la disminución de costos y riesgos de las entidades financieras, al igual que la mejora de la calidad de servicios que ofertan a los participantes del sistema financiero (European Central Bank, 2019) La innovación financiera en términos de riesgo compartido incrementa la liquidez y tiene un efecto de competencia intenso, su uso para desarrollar mercado de crédito aumenta la asignación eficiente del riesgo crediticio. Grydaki & Bezemer (2013) han revelado que la innovación financiera incrementa el flujo de liquidez y de los créditos en volumen y por ende se incrementan los ingresos de las entidades financieras.…”

A Note on Measuring Us Time Series Volatility During the Great Moderation

“…Carvalho and Gabaix (2013)) argue that a shift in GDP's composition toward higher volatility sectors, such as finance, reduced stability prior to the onset of the Great Recession. Relatedly, Grydaki and Bezemer (2013) suggest that output volatility may have fallen during the Great Moderation precisely because of a credit expansion that enabled spending out of wealth. They also suggest that the same expansion may explain the increase in volatility during the Great Recession.…”