Academic journal article Economic Inquiry

Fiscal Policy and Lending Relationships

Academic journal article Economic Inquiry

Fiscal Policy and Lending Relationships

Article excerpt

I. INTRODUCTION

During the Great Moderation the mainstream business cycle literature argued that any policy instrument other than the monetary policy rate played only a minor role in stabilizing the economy, this being the main reason why the focus on discretionary fiscal policy as a countercyclical tool was very limited (see e.g., Blanchard et al. 2010). As the recent crisis began, it was clear that fiscal policy was at least a dimension along which governments could do more, having soon realized that the crisis was taking a global and profound dimension, it was expected to be long-lasting, and the monetary policy interest rate, in many cases, had almost reached the zero lower bound.

Modern macroeconomics agrees on the fact that credit market conditions significantly affect business cycle dynamics (see e.g., Bean 2010; Christiano et al. 2014). In the empirical literature there is evidence that credit spreads widen during downturns (see Aliaga-Diaz and Olivero 2010, 2011; Gertler and Lown 1999; Villa and Yang 2011, among many others) and the dynamic stochastic general equilibrium (DSGE) literature offers a variety of explanations (see Bernanke et al. 1999; Christiano et al. 2014; Gertler and Kiyotaki 2010; Gertler and Karadi 2011, among others). As far as the bank spread is concerned, that is, the difference between the loan rate and the deposit rate, an appealing but less studied determinant is offered by lending relationships. Aliaga-Diaz and Olivero (2010) provide empirical evidence of lending relationships. These imply that banks hold up borrowers because the former gain an information monopoly over customers' creditworthiness and the latter find it costly to switch to a new funding source. This piece of evidence agrees with the analysis of Santos and Winton (2008), who empirically show that during recessions banks raise the bank spread more for bank-dependent borrowers than for those with access to public bond markets. According to Santos and Winton, the increase in the bank spread due to the informational hold up effect reaches 95 basis points in U.S. data. Petersen and Rajan (1994) estimate that in the U.S. loan market the average duration of lending relationships is 11 years. The hold-up problem in the loan market, however, is not a phenomenon involving only the United States. The European Commission (2007) reports increasing switching costs also in the EU loan market, and there exists a substantial body of microeconometric evidence of lending relationships in a number of European countries, such as Italy, Belgium, and Norway, where average lending relationship durations are in the order of 10 years (see Angelini et al. 1998; Degryse and Van Cayseele 2000; Kim et al. 2003, among others).

Given the empirical relevance of lending relationships and the renewed interest in fiscal policy, natural questions are then: what are the typical effects of a government spending expansion on lending and the bank spread? And how is such a fiscal shock transmitted within an economy featuring lending relationships? Although in the literature there are papers investigating the stabilization properties of fiscal policy in DSGE models with credit frictions (see, e.g., Canzoneri et al. 2012; Carrillo and Poilly 2013; Fernandez-Villaverde 2010), these studies do not focus specifically on how a fiscal stimulus affects loan market conditions and do not take lending relationships into account. This paper fills in this gap on one hand by estimating the response of lending and the bank spread to a government spending expansion in a structural vector-autoregressive (SVAR) model of the U.S. economy. On the other hand, it develops a real business cycle (RBC) model with lending relationships able (1) to match to a significant extent the empirical findings and (2) to provide a theoretical framework that allows one to study how the fiscal stimulus is transmitted via a banking sector characterized by the presence of long-lasting lending relationships. …

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