Kaiji Chen, Patrick Higgins, and Tao Zha
Working Paper 2020-6
May 2020

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Abstract: Lending standards are a direct measure of credit conditions. We use the micro data merged from three separate sources to construct this measure and document that an uncertain macroeconomic outlook, rather than banks' balance sheet positions, was an important reason that a majority of banks tightened bank lending standards during the Great Recession. Our extensive data analysis disciplines how we introduce credit frictions in the banking sector into a macroeconomic model. The model estimation reveals that an exogenous shock to credit supply drives cyclical lending standards and accounts for a significant portion of fluctuations in bank loans and aggregate output.

JEL classification: E32, E44, G21, C51, C81, C82

Key words: asymmetric credit allocation, endogenous regime switching, debt-to-GDP ratio, heavy GDP, heavy loans, real estate, land prices, GDP growth target, nonlinear effects

https://doi.org/10.29338/wp2020-06Off-site link

The authors thank Lars Hansen, Boyan Jovanovic, Vincenzo Quadrini, Juan Sanchez, and seminar participants at the University of Notre Dame, the University of Illinois, the 2017 AEA meeting, the 2016 SED meeting, the Bank of Korea, the European Central Bank, the Federal Reserve Bank of St. Louis, and the Federal Reserve Board of Governors for helpful discussions. Tong Xu provided superlative research assistance. Earlier versions of this paper were titled "Lending Efficiency Shock." The research is supported in part by the National Science Foundation grant SES 1558486 through the NBER and by the National Natural Science Foundation of China Research grants 71633003 and 71473168. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or the National Bureau of Economic Research. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Kaiji Chen, Department of Economics, Emory University, 1602 Fishburne Drive, Atlanta, GA 30322-2240 and Federal Reserve Bank of Atlanta, Patrick Higgins, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470; or Tao Zha, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, and Emory University and NBER.

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