Bank loan supply fluctuations are responsible for disturbances in GDP in our sample of countries. Results obtained provide further support for the already existing evidence for the US. The impact of bank credit on macro-economic fluctuations has always been a topic of interest in monetary economics.
Bank loan supply fluctuations are responsible for disturbances in GDP in our sample of countries. Results obtained provide further support for the already existing evidence for the US. The impact of bank credit on macro-economic fluctuations has always been a topic of interest in monetary economics.
Bank loan supply fluctuations are responsible for disturbances in GDP in our sample of countries. Results obtained provide further support for the already existing evidence for the US. The impact of bank credit on macro-economic fluctuations has always been a topic of interest in monetary economics.
This paper investigates the impact of bank lending supply fluctuations on economic activity in a multitude of developed and developing countries, (Argentina, Brazil, Venezuela, Indonesia, India, Malaysia, Thailand, Australia, New Zealand, Belgium, France, Italy, Germany, Spain, UK, Japan, Turkey, South Africa and the USA,). Our methodology is based on an unrestricted VAR system, following earlier work by C. Walsh and J. Wilcox (1995) for the US. Our results show that bank loan supply fluctuations are responsible for disturbances in GDP in our sample of countries. Results obtained provide further support for the already existing evidence for the US (Walsh and Wilcox 1995, Friedman and Kuttner 1993 among others).
Key words: Bank loans, Economic activity, macro-economic shocks
Field of Research: Banking, Monetary economics
1. Introduction
The impact of bank credit on macro-economic fluctuations has always been a topic of interest in monetary economics (Meltzer and Brunner 1963, Bernanke and Blinder 1983). The importance of this role stems from the fact that small firms and households depend only on bank finance. In monetary history, the era post the Great Depression has been characterized by contractions on output during money supply fluctuations (Friedman & Schwartz 1963). Monetary research has seen substantial investigations on the relationship between money and output, due to bank credit been the main counterpart of money on banks balance sheets a similar relationship between credit and output is supposed to exist (Bernanke 1983). Bank loan supply fluctuations were found as well to affect GDP levels in the USA (Friedmann and Kuttner 1993, Walsh and Wilcox 1995). In the Euro Area Sousa and Calza 2005 found clear evidence of fluctuation in economic activity due to bank loan supply disturbances. Therefore the purpose of this paper is to investigate the impact of bank loan supply fluctuations on economic activity. We use aggregate monthly data for Argentina, Brazil, Venezuela, Indonesia, India, Malaysia, Thailand, Australia, New Zealand, Belgium, France, Italy, Germany, Spain, UK, Japan, Turkey, South Africa and the USA. Our data sample has been obtained from Central Banks of the relevant countries as well as the IFS (International Financial Statistics) online. Except for GDP all our data are seasonally adjusted. Our methodology applied is an un- restricted VAR methodology in line with Walsh and Wilcox 1995. We therefore controlled as well for the impact of bank loan demand shocks, policy shocks as well as inflationary shocks. Our results are in line with earlier research (Walsh and Wilcox 1995) and (Friedman and Kuttner 1993) show a clear impact of bank loan supply shocks in economic activity. The paper is organised as follows; Section 2 provides a short description of the econometric methodology used in the different phases of the
1 I would like to thank my Supervisor Professor Phil Molyneux for all his help and support his very useful insights and guidance. All remaining errors or emissions are entirely my responsibility. 2 Author Iman Sharif - PhD Researcher - Bangor Business School UK email: abp81d@bangor.ac.uk
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empirical investigation. Section 3 describes the results of estimating the Unrestricted VAR and testing for existing effects. Section 4 presents the impulse responses of output and inflation to a one-standard error shock to credit growth. Section 5 includes some conclusions and suggestions for further work.
2. Literature review
The post Great Depression Era (1933) has seen a great amount of research devoted to investigate the relationship between money and aggregate demand. Friedman and Schwartz (1963) found contractions on output during money supply fluctuations. Following this finding substantial resources have been devoted to studying the relationship between money and output. Given that credit is the main counterpart of money on the balance sheets of banks, a similar relationship between credit and output should also exist (Bernanke 1983). Bernanke built on Freidman and Schwartz work by considering the effect of this credit squeeze on aggregate demand, and found that the squeeze in credit supply helped convert the severe downturn of 1929- 1933 into an extensive depression. Later Blinder (1987) in his investigation found that the behaviour of the economy may be qualitatively different depending on whether or not the credit constraint is binding. Bernanke and Gertler, 1989; Kiyotaki and Moore, 1997; and Azariadis and Smith, 1998) have found in the context of general equilibrium models incorporating financial market imperfections, that temporary shocks to credit supply can generate large and persistent fluctuations in output. More recent evidence by Friedman and Kuttner 1993 and Walsh and Wilcox 1995, using a VAR approach on US data found that fluctuations in bank loan supply were indeed responsible for fluctuations in GDP. In Europe, Sousa and Calza 2005 found clear evidence of fluctuation in economic activity due to bank loan supply disturbances.
3. Model, data and findings (The Un-restricted VAR)
In this section we describe the methodology used to analyse our data. We use vector auto-regressions (VAR) to assess a number of hypotheses about the interaction of bank loan supply, bank loan demand, inflation and monetary policy with economic activity. We apply the standard Choleski decomposition method to our estimated un- restricted VARs (vector auto-regression) models. Our results present further evidence that the Cholesky decomposition does a creditable job of distinguishing shocks to the supply of bank loans from shocks to the demand for bank loans. The ordering of the variables applied to our study is similar to that of Walsh 1995 and Friedman and Kuttner 1993. This is more evidence that the Choleski decomposition is successful in splitting the demand effect from the supply effect. A different ordering of the variables showed different results. In previous empirical investigations of the relation between bank lending and output (e.g. Walsh and Wilcox 1995), and in numerous other investigations that used aggregate data, either quarterly data (Friedman and Kuttner 1993), the index of industrial production was used as a proxy for aggregate output. In our study we used monthly data but avoided the proxy for aggregate output (index of industrial production) as it presents problems of narrowness of measure. Instead we chose to work out a larger measure for output using different GDP components such as: GDP = Aggregate Consumption + Aggregate Investment + (Government Spending) + (Exports Imports).
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The present study employed aggregate monthly data obtained from the IFS (International Financial Statistics), OECD (Organisation for Economic Cooperation and Development) and Central banks websites of the relevant countries in question. All our data are inflation adjusted except for GDP. The Vector Auto-regressive (VAR) process based on normally distributed errors (Gaussian) has frequently been a popular choice for describing macro-economic time-series data. Many reasons favour this, due to its flexibility, easy to estimate and usually gives a good fit to macro-economic data. VAR models offer the possibility of combining long-run and short-run information in the data by exploiting the co-integration property. This property is one of the main reasons why both economists and econometricians continue to keep interest in VAR models. This model can be extended to the case where there are k lags (3 lags in our case) of each variable in each equation: Our un- restricted VAR model is based on the following assumptions: X t = H 1 X t-1 + H 2 X t- 2 + .....+ uD t + c t T = 1, , T c t IN p (0, O), Where D t = [Dq1t, Dq2t, Dq3t, 0| contains three centred seasonal dummies and a constant.
We ran an OLS regression equation by equation. As we discussed those estimates was ML (maximum likelihood) as we imposed no restrictions on our VAR models. Our estimated coefficients show (F-Tests) that for all countries in question some coefficients are significant at all 3 lags (i.e. lag1 and lag2 and 3 rd lag). GDP and Bank Loans seem to be the most important variables of the system. The main aim behind the application of the Choleski decomposition to our VAR regressions is to estimate the VAR models with un-correlated residuals so as to split the loan demand effect from the loan supply effect. The Choleski decomposition requires a certain ordering of the variables in the model as a different ordering gave us different results. This ordering of variables is in line with Walsh and Wilcox 1995, Friedman and Kuttner 1993. Our study therefore adds to the evidence that the impact of these shocks through restrictions imposed on the unrestricted VAR. The triangular form VAR is exactly identified by zero restrictions on A 0 and sigma respectively. The triangular system is based on a specific ordering of the p variables and thus on an underlying assumption of a causal chain. Our dataset showed a highly autoregressive nature this has been evident from the large t-ratios obtained diagonally on matrices of our data sets investigated.
As VAR models are often difficult to interpret: a proposed solution is constructing the impulse responses and variance decompositions (Appendix I, II and III) Impulse responses trace out the responsiveness of the dependent variables in the VAR to shocks to the error term. A unit shock is applied to each variable and its effects are noted. A change in u t will immediately change y t . It will change y 2 and also y 1 during the next period. We can examine how long and to what degree a shock to a given equation has on all of the variables in the system. Further robustness was obtained by testing for co-integration between bank loans and economic activity (GDP), results have shown that there is no unit root on our data and that the two important variables in question Bank Loans and GDP do co-integrate in the long run.
4. Results and interpretations: The impact of bank loan supply shocks on GDP
All results of the countries investigated show impulse response figures that trace the impact of bank loan supply shocks on GDP. In fact our results provide further Sharif
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evidence that bank loan supply shocks do transmit their fluctuations to GDP in the short run as well as in the long run as both variables do co-integrate. Our European sample (Belgium, France, Germany, Italy, Ireland, Spain and UK) impulse response results show that Germany exhibits a steep negative loan supply shock of the 1990s that has in turn been transmitted to GDP and hence caused slowdown in the level of economic activity (GDP). This finding could be related to the economic condition of the times during the German re-unification of the economy. Our impulse response figures show in the case of Germany, that both bank loan supply and GDP (economic activity measure) reacted in a similar way to the policy shocks at their interaction. Loan supply shocks in Belgium Italy and Spain are comparable in size and timing and have as well transmitted their disturbances to economic activity (GDP). A possible explanation of the direct impact on bank loan supply on economic activity in Europe (except for the UK) is that bank lending in Europe constitutes the main source of external funds. This is consistent with the conclusions drawn by De Bondt (2000); Hauselwig et al. have suggested that banks decrease their loan supply with an expected fall in the credit margin following a macro-policy shock, while loan demand declines with a drop in the output level and a raise in the loan rate. Our results confirm again the same finding that policy shocks cause bank loan supply to slow down. UK impulse response figures show differences in the reaction of bank loan supply compared to its European counterparts. Our Impulse response figures show that bank loan supply in the UK shows stable movements. The trend in bank loan supply in the UK has witnessed a significant increase between 1998 and 1999. This increase of bank loan supply in the UK has been due to the large number of mergers and acquisitions that took place in the UK market early in 1997. Loan supply fluctuations in the UK show a different pattern compared to loan supply in the other European countries of our sample Europe. This is due to the high market capitalization of the UK financial market. Bank loan supply and GDP show a similar cyclical pattern for both variables.
As the period of our study (1997 2006) represents the aftermath of the financial crises in Argentina during 1995 1996, that resulted in a dramatic fall in credit and output levels (Agenor et al. 2002). The same applies to the other Latin American countries of our sample i.e. Brazil and Venezuela. Our impulse response figures show both GDP and bank loan supply levels witness steep negative slumps both the level of GDP and bank loan supply to rise gradually to positive levels. The improvement in GDP levels following the aftermath of the crisis is related to an improvement in the conduct of monetary policy in the respective countries.
Bank credit supply in India, Indonesia, Malaysia and Thailand shows steep negative slumps in all respective countries investigated. This has as well been responsible for the drop in economic activity levels. This reflects the impact of the Asian crisis of 1997 bank loan supply and GDP. Our sample shows an improvement on GDP levels and bank loan supply levels from 2000 onwards this improvement is due to the intensive lending activity undertaken by banks in the respective countries. The slow- down in bank loan supply in (India, Indonesia, Malaysia and Thailand) was accompanied by an increase in inflationary levels as clear from our results.
Our results show that the trend of bank loan supply shocks in the United States is mainly an expansionary one. Unlike all countries of our sample bank loan supply in the US is positive. In line with the UK economy the US economy is mainly a market Sharif
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based economy. Banks are not the only major players in the US market they are present alongside securities markets. According to our impulse response analysis the impact of bank loan supply shocks on the US economy (GDP) shows an up-ward trend at their interaction. This increase in GDP lasted longer in time than all other countries examined. This was followed by a slight economic down-turn. This is an indication that loan supply shocks have an impact on GDP that lasts longer in time than in other countries examined. This result is in line with (Peek et. al. 2003) findings for the USA which indicated that bank loan supply shocks had an impact on the US economy when bank loan supply is reduced.
5. Conclusions
The present study has investigated whether bank credit supply fluctuations transmits their disturbances into the economy. Our sample is a multitude of countries (Argentina, Brazil, Venezuela, Indonesia, India, Malaysia, Thailand, Australia, New Zealand, Belgium, France, Italy, Germany, Spain, UK, Japan, Turkey, South Africa and the USA). Our model controlled for the impact of bank loan supply shocks on economic activity (GDP) taking into account three other macro-economic shocks (bank loan demand shock, inflation shock and policy shock). The data employed to test our model is a monthly aggregate set. Our model is a vector auto-regression (VAR) that allowed us to assess the impact of bank loan supply disturbances on the economy at both the short run and on the long run.
Our results present as well more evidence to the already existing evidence by Friedman- Kuttner, 1993 and Walsh-Wilcox 1995. Our sample of European investigated (Belgium, France, Germany, Italy, Ireland, Spain and UK) that disturbances in bank loan supply have been transmitted to the economy. The period of our study has been mainly marked by the German re-unification and as bank lending is the main source of finance in European countries (except for the UK) our results showed a direct impact of bank loan supply fluctuations on GDP. In the Latin American countries investigated our results show that bank loan supply disturbances have been transmitted to the economy. The timing of our sample has been marked by the aftermath of the financial crisis in the Latin American continent. Results for the East Asian countries show a clear impact of bank loan supply shocks the period investigated was following the Asian financial crisis bank loan supply disturbances in the East Asian region have as well been accompanied by exacerbated inflationary pressures. The same conditions apply as well to Turkey and South Africa. Our results for Japan exhibit the same conditions as for other countries the economic explanation is the impact of the banking crisis in Japan. According to our impulse response results for the US economy, bank loan supply shocks on GDP the impact of the shocks last longer in time than in other countries examined. This result is in line with earlier evidence (Peek et. al. 2003) for the USA which indicated that bank loan supply shocks had an impact on the US economy when bank loan supply is reduced. Our results present therefore, more evidence that bank loan supply fluctuations are transmitted into the economy (Friedman and Kuttner 1993 and later Walsh and Wilcox 1995).
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Appendix I
Impact of bank loan supply fluctuations on GDP in Australia, New Zealand, Argentina Brazil, Venezuela, South Africa, Turkey & Japan during 1997(1) - 2006(12):
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Appendix II Impact of bank loan supply fluctuations on GDP in Belgium, France, Germany, Ireland, Italy, Spain, UK and US during 1997(1) 2006(12) :-
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Appendix III Impact of bank loan supply fluctuations on GDP in Malaysia, India, Indonesia and Thailand during 1997(1) 2006(12):-