Working Paper: NBER ID: w23850
Authors: Arvind Krishnamurthy; Tyler Muir
Abstract: We study the behavior of credit and output across a financial crisis cycle using information from credit spreads and credit growth. We show the transition into a crisis occurs with a large increase in credit spreads, indicating that crises involve a dramatic shift in expectations and are a surprise. The severity of the subsequent crisis can be forecast by the size of credit losses (change in spreads) coupled with the fragility of the financial sector (as measured by pre-crisis credit growth), and we document that this interaction is an important feature of crises. We also find that recessions in the aftermath of financial crises are severe and protracted. Finally, we find that spreads fall pre-crisis and appear too low, even as credit grows ahead of a crisis. This behavior of both prices and quantities suggests that credit supply expansions are a precursor to crises. The 2008 financial crisis cycle is in keeping with these historical patterns surrounding financial crises.
Keywords: credit cycles; financial crisis; credit spreads; economic downturn
JEL Codes: E0; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large increase in credit spreads (F65) | transition into a financial crisis (P34) |
| size of increase in credit spreads + extent of pre-crisis growth in credit (F65) | severity of financial crisis (G01) |
| high credit growth + low credit spreads (E51) | incidence of financial crises (G01) |
| change in spreads (F31) | future economic output (E23) |
| credit supply expansions (E51) | incidence of financial crises (G01) |
| behavior of credit markets (E44) | economic outcomes (F61) |