Relationship between economic policy uncertainty and domestic credits: evidence from the long-span time series for the UK and the USA

ABSTRACT

This paper examines the effects of news-based economic policy uncertainty (EPU) on domestic credit in the United Kingdom and the United States from 1900 to 2020. The Structural Vector Autoregression (SVAR) model results show that the EPU significantly decreases domestic credit both in the United Kingdom and the United States. Further results from the Volatility Spillover model indicate robust evidence of the negative impact of the EPU on domestic credit demand. The high spillover effect comes from the high EPU, which is associated with low domestic credit, and the low EPU is associated with increased domestic credit. The results are robust in different model procedures. The results indicate that consumers decrease durable consumption, and firms follow a wait-and-see strategy during times of higher EPU.

KEYWORDS:

• Domestic credits
• economic policy uncertainty
• money supply
• SVAR model
• Volatility spillover approach

JEL CLASSIFICATION:

• E51
• D81
• O11
• C32

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Our data started in 1900, but the Federal Reserve Act was validated in 1913. According to the National Banking Act, the money supply was provided within the 1900–1913 years, which offered a standardized currency backed by the United States Securities.

² https://www.macrohistory.net/database. The data used in Jordà et al (2017, Jordà et al. 2019, 2021). can also be accessed from this website

³ www.policyuncertainty.com

⁴ We also include the oil price as an exogenous shock; the results are similar to the baseline findings.

⁵ The theoretical background of the Cholesky Decomposition approach is not discussed here to keep the paper short. Instead, interested readers may see Kilian (2013) for the requirements and structural identification process of the SVAR model.

⁶ Interested readers are advised to see Diebold and Yilmaz (2009, 2012) for a detailed explanation of finding the net spillovers from a generalized VAR model.

⁷ As a robustness check, a 35-month rolling window is used to calculate the net spillover from the EPU to domestic credit for the US (see Appendix Figure A1) and the UK (see Appendix Figure A2). Appendix Figures 1 and 2 are very similar to Figures 6 and 12, respectively, indicating that the number of prior observations does not change the nature of net spillover from the EPU to domestic credit over time.

Figure 1. Responses to the US EPU shock in the United States economy (baseline findings).

The solid line represents responses, and the dashed lines represent upper and lower confidence intervals. When the stable line and the confidence intervals are below (above) the X-axis, the response is significantly negative (positive). The figure indicates that an uncertainty shock decreases loans considerably for almost all periods. Also, the same shock reduces real GDP for the first two years. But, the same shock significantly increases the money supply for all periods.

Figure 2. Responses to the US EPU shock in the United States economy (the SVAR model with six lags).