Bank Credit and the Macroeconomy - Cross-country Evidence

• Applicant: Professor Dr. Sascha Steffen
• Subject Area: Accounting and Finance
• Term: from 2020 to 2021
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 437674771

We empirically investigate the role of bank credit in the macroeconomy across countries with a focus on the U.S. and Europe. More specifically, we develop a loan-based credit spread, explore its predictive power for industry-level and aggregate macroeconomic variables and investigate whether it reflects frictions in the supply of bank lending to non-financial firms. One key innovation in this project is that we do not only use credit spread measures based on bond prices, but explicitly examine the predictive power of the loan market. To that end, we introduce a novel credit spread measure based on loan market prices. Loan markets are not only important in terms of the overall economic impact of credit supply availability, but banks are also allowed to trade on private information, which is reflected in secondary market prices. Importantly, we can exploit an international sample of data including the U.S. and major European countries (e.g. U.K., Germany, France, Italy and Spain). While the U.S. and the U.K. for example, might be similar given the depth of their respective bond markets, the predictive power of the loan market might be elevated in countries such as Germany and Italy that rely more on bank financing.A second key innovation is the focus on industry-level data. Prior research has ignored these industry cycles. Recent theoretical work, however, highlights the importance of microeconomic evidence to understand macroeconomic outcomes. From a methodological perspective, examining disaggregated data, and industry cycles in particular, can help us understand as to why credit spreads have predictive power for macroeconomic outcomes. Importantly, studies using aggregate data cannot investigate whether changes in spreads are related to changes in the supply of loans from the banking sector as they cannot control for loan demand. This is precisely what we propose to do with our micro-level data.The proposed project has four parts:(1) Investigate the anatomy of the primary and secondary loan and bond markets in an international setting. (2) Investigate the predictive power of loan market credit spreads for business cycle outcomes using cross-country data.(3) Identify the sources of the predictive power of loan vis-à-vis bond spreads, developing quarterly bank loan supply and demand indices by industry and country.(4) Develop a measure to predict (country-specific) economic downturns.

• DFG Programme: Research Grants