All told, the conclusion that we draw from a large body of research into the links between household debt, the housing market, and business cycles is that expansions in credit supply, operating primarily through household demand, are an important driver of business cycles generally. We call this the “credit-driven household demand channel.” An expansion in the supply of credit occurs when lenders either increase the quantity of credit or decrease the interest rate on credit for reasons unrelated to borrowers’ income or productivity.
In a new
study, we show that the credit-driven household demand channel rests on three main conceptual pillars.
First, credit-supply expansions, rather than technology or permanent income shocks, are the key drivers of economic activity. This is a controversial idea. Most models attribute macroeconomic fluctuations to real factors such as productivity shocks. But we believe the financial sector itself plays an underappreciated role through its willingness to lend.
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