Anda di halaman 1dari 10

Journal of Business & Policy Research

Volume 5. Number 1. July 2010 Pp. 179 - 188

Bank credit and economic activity

Iman Sharif

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

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.
Author Iman Sharif - PhD Researcher - Bangor Business School UK email:



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).



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
= H
+ H
+ .....+ uD
+ c
T = 1, , T c
(0, O), Where D
= [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
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
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
will immediately change y
. It will change y
and also y
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


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


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).




Angeloni, I., Kashyap, A., Mojon, B. and Terlizzese D. 2003. The output composition
puzzle: A difference in the monetary transmission mechanism in the euro area and U.S..
ECB Working Paper No. 268.

Atanasova, C. 2003. Credit market imperfections and business cycle dynamics: A non-
linear approach. Studies in Nonlinear Dynamics and Econometrics, Vol. 7, No. 4, pp.

Azariadis, C. and Smith, B. 1998. Financial intermediaries and regime switching in
business cycles. American Economic Review, Vol. 88, No. 3, pp. 516-536.

Balke, N.S. 2000 Credit and economic activity: credit regimes and nonlinear propagation
of shocks. Review of Economics and Statistics, Vol. 82, No. 2, pp. 344-349.

Bernanke, B. 1993 Credit in the Macro-economy. Federal Reserve Bank of New York
Quarterly Review, Vol. 18, No. (1), pp. 50-70.

Bernanke, B. and Gertler, M. 1989. Agency costs, net worth and business fluctuations.
American Economic Review, Vol. 79, No. 1, pp. 14-31.

Blinder, A.S. 1987. Credit rationing and effective supply failures. The Economic Journal,
Vol. 97, No. 386, pp.327-352.

De Bondt, G.J. 2000. Financial Structure and Monetary Transmission in Europe. A Cross-
country Study. Cheltenham: Edward Elgar.

Calza, A., Manrique, M. and Sousa, J. 2003. Aggregate loans to the euro area private
sector. ECB Working Paper No. 202.

Cecchetti, S.G. 1995. Distinguishing theories of the monetary transmission mechanism.
Federal Reserve Bank of St. Louis Review, Vol. 77, pp.83-97.

Ehrmann, M., Ellison, M. and Valla, N. 2003. Regime-dependent impulse response
functions in a Markov-Switching vector autoregression model. Economics Letters, Vol.
78, pp. 295-299.

Ehrmann, M., Gambacorta, L., Martnez-Pags, J., Sevestre, P. and Worms, A. 2003.
Financial systems and the role of banks in monetary policy transmission in the euro area.
In Angeloni, I., Kashyap, A. and Mojon, B. (eds) Monetary transmission in the euro area.
Cambridge: Cambridge University Press, pp. 235-269.

Friedman, B. and Schwartz, A. J. 1963. A Monetary History of the United States, 1867-
1960. Princeton, NJ: Princeton University Press.

Friedman B. M. And Kuttner 1993, Economic activity and the short term credit markets,
Brookings Papers on Economic activity, Vol. 2



Galbraith J.W. 1996. Credit rationing and threshold effects in the relation between money
and output. Journal of Applied Econometrics, Vol. 11, No. 4, pp. 416-429.

Gallant, A.R., Rossi, P.E. and Tauchen, G. 1993. Nonlinear dynamic structures.
Econometrica, Vol. 61, No.4, pp. 871-908.

Gertler, M. 1988 Financial structure and aggregate economic activity: an overview.
Journal of Money, Credit and Banking, Vol. 20, N. 3, pp. 559-596.

Gilchrist, S. G., and E. Zakrajsek 1995. The Importance of Credit for Macroeconomic
Activity: Identification through Heterogenity," in Is Bank Lending important for the
Transmission of Monetary Policy?, ed. by J. Peek, and E. S. Rosengreen, vol. 39 of
Federal Reserve Bank of Boston Conference Series,, pp. 129{158, Boston.

Johansen, S., and K. Juselius 1990. Maximum Likelihood Estimation and Inference on
Cointegration { With Applications to the Demand for Money," Oxford Bulletin of Economics
and Statistics, 52(2), 169{210

Kiyotaki, N. and Moore, J. 1997. Credit cycles. Journal of Political Economy, Vol. 105,
N.2, pp. 211-248.

McCallum, J. 1991. Credit rationing and the monetary transmission mechanism.
American Economic Review, Vol. 81, No. 4, pp. 946-951.

Walsh, C.E. and Wilcox, J.A. 1995. Bank credit and economic activity. In Peek J. and
Rosengren, E.S. (eds) Is bank lending important for the transmission of monetary policy?,
Federal Conference Series No. 39, Boston: Federal Reserve Bank of Boston, pp. 83-112.

Walsh, C.E. 1998. Monetary Theory and Policy. Cambridge, MA and London: The MIT



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):



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) :-



Appendix III
Impact of bank loan supply fluctuations on GDP in Malaysia, India, Indonesia and Thailand
during 1997(1) 2006(12):-