Very excited that our paper (w/ @AtifRMian and @profsufi) “How Do Credit Supply Expansions Affect the Real Economy: The Productive Capacity and Household Demand Channels” is now forthcoming at the Journal of Finance! 1/
@AtifRMian @profsufi The paper makes a simple point that we hope will be useful to researchers studying past credit booms and to policymakers evaluating risks in future booms.
Let me try to describe the basic idea. 2/
Let me try to describe the basic idea. 2/
@AtifRMian @profsufi Credit expansions can affect the economy by increasing firm productive capacity (e.g., constrained firms borrow and grow) or by boosting demand (e.g., households borrow to boost consumption). 3/
@AtifRMian @profsufi The distinction matters, since there is some theory and evidence suggesting that credit expansions that boost demand may be more likely to lead to economic slowdowns and financial crises down the road. 4/
@AtifRMian @profsufi We develop a simple framework showing that credit expansions that boost household demand display two key features that distinguish them from those that boost productive capacity. 5/
@AtifRMian @profsufi Credit expansions that boost demand lead to (i) a reallocation of employment from the tradable to the non-tradable sector and (ii) to real exchange rate appreciation. Credit expansion that increases productive capacity should have a negligible effect on these variables. 6/
@AtifRMian @profsufi We then apply this test to various credit supply expansions, including the period of staggered banking deregulation in the US in the 1980s and a broader panel of countries over the past several decades. Let me focus on the 1980s deregulation case to illustrate the basic point. 7/
@AtifRMian @profsufi Throughout the 1980s, states gradually lifted geographic restrictions on banks' ability to compete within and across states. As a result, early deregulation states saw larger credit expansions during the 1980s aggregate credit cycle. 8/ 
@AtifRMian @profsufi The 1980s banking deregulation case is often considered to be an example of a credit supply expansion that boosted productive capacity.
However, we find that the household demand channel played an important role in this episode. 9/
However, we find that the household demand channel played an important role in this episode. 9/
@AtifRMian @profsufi First, states that deregulated earlier in the 1980s expansion saw stronger growth in non-tradable employment (e.g., restaurant and retail, construction), but no growth in tradable employment (e.g., manufacturing).
@AtifRMian @profsufi Second, early deregulation states also saw "real appreciation" in the form of rising prices of non-tradable goods.
The reallocation to non-tradables and the increased scarcity of non-tradables suggests that a deregulation-induced credit expansion fueled a demand boom. 11/
The reallocation to non-tradables and the increased scarcity of non-tradables suggests that a deregulation-induced credit expansion fueled a demand boom. 11/
@AtifRMian @profsufi How did these early deregulation states do several years later?
The early deregulation states that saw a stronger credit boom in the 1980s also witnessed a *more severe downturn* during the 1990/91 recession. 12/
The early deregulation states that saw a stronger credit boom in the 1980s also witnessed a *more severe downturn* during the 1990/91 recession. 12/
@AtifRMian @profsufi In sum, observing a credit expansion alongside reallocation to non-tradables and real appreciation is a sign that the credit expansion is boosting demand.
In US and international data, these credit-supply-induced demand booms are also likely to lead to busts down the road. end/
In US and international data, these credit-supply-induced demand booms are also likely to lead to busts down the road. end/
