Dynamic Effects of Credit Shocks in a Data-Rich Environment

ABSTRACT

We examine the dynamic effects of credit shocks using a large dataset of U.S. economic and financial indicators in a structural factor model. An identified credit shock resulting in an unanticipated increase in credit spreads causes a large and persistent downturn in indicators of real economic activity, labor market conditions, expectations of future economic conditions, a gradual decline in aggregate price indices, and a decrease in short- and longer-term riskless interest rates. Our identification procedure allows us to perform counterfactual experiments which suggest that credit spread shocks have largely contributed to the deterioration in economic conditions during the Great Recession. Recursive estimation of the model reveals relevant instabilities since 2007 and provides further evidence that monetary policy has partly offset the effects of credit shocks on economic activity. Supplementary materials for this article are available online.

Key words:

• Credit shocks
• FAVAR
• Structural factor analysis

SUPPLEMENTARY MATERIALS

The supplementary material contains: (i) simulation results for structural shocks identication scheme; (ii) theoretical impulse responses from a DSGE model; (iii) robustness analysis; (iv) additional results; (v) comparison with a small-scale VAR model, and (vi) the data appendix.

ACKNOWLEDGMENTS

The authors thank Todd Clark and anonymous referees for valuable comments. The views expressed in this article are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of Dallas, or the Federal Reserve System.

Additional information

Funding

The author acknowledges financial support from the Social Sciences and Humanities Research Council.