The role of credit in the Great Moderation: A multivariate GARCH approach


Grydaki M & Bezemer D (2013) The role of credit in the Great Moderation: A multivariate GARCH approach. Journal of Banking and Finance, 37 (11), pp. 4615-4626.

During the Great Moderation, financial innovation in the US increased the size and scope of credit flows supporting the growth of wealth. We hypothesize that spending out of wealth came to finance a wider range of GDP components such that it smoothed GDP. Both these trends combined would be consistent with a decrease in the volatility of output. We suggest testable implications in terms of both growth of credit and output and volatility of growth. In a multivariate GARCH framework, we test this view for home mortgages and residential investment. We observe unidirectional causality in variance from total output, residential investment and non-residential output to mortgage lending before, but not during the Great Moderation. These findings are consistent with a role for credit dynamics in explaining the Great Moderation.

Great Moderation; Mortgage credit; Multivariate GARCH; Causality

Journal of Banking and Finance: Volume 37, Issue 11

Publication date30/11/2013