How Does Credit Supply Expansion Affect the Real Economy? The Productive Capacity and Household Demand Channels

Abstract

Credit supply expansion can affect an economy by increasing productive capacity or by boosting household demand. In this study, we develop a test to determine if the household demand channel is present, and we implement the test using both a natural experiment in the United States in the 1980s and an international panel of 56 countries over the last several decades. Consistent with the importance of the household demand channel, we find that credit supply expansion boosts nontradable sector employment and the price of nontradable goods, with limited effects on tradable sector employment. Such credit expansions amplify the business cycle and lead to more severe recessions.