Financial fragility in the Great Moderation |
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| Affiliation: | 1. Faculty of Economics and Business, University of Groningen, The Netherlands;2. Division of Economics, University of Stirling, United Kingdom;1. Baylor University, United States;2. Loyola University Maryland, United States;3. KAIST, Republic of Korea;1. School of Business, University of Alberta, Canada;2. Department of Economics, Hitotsubashi University, Japan;1. Dipartimento di Scienze Economiche e dell’Impresa, University of Florence, Florence, Italy;2. Department of Economics, University of Bologna, Bologna, Italy;1. Knut Wicksell Centre of Financial Studies, Lund University School of Economics and Management, Research Institute of Industrial Economics, Sweden;2. Center for Institutional Investment Management, SUNY at Albany, USA;3. Skiermont Puckett, LLP, USA;1. College of Business, Oregon State University, Corvallis, OR 97331, USA;2. Robert J. Trulaske Sr., College of Business, University of Missouri, Columbia, MO 65211, USA |
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| Abstract: | A nascent literature explores the measurement of financial fragility. This paper considers evidence for rising financial fragility during the 1984–2007 Great Moderation in the U.S. The literature suggests that macroeconomic stability combined with strong growth of credit to asset markets, in asset prices and in credit relative to output are all indicators of rising financial fragility. We show each of these trends in the Great Moderation. We derive the testable implication that in the Great Moderation credit growth is driven more by past credit growth and less by output growth (Allen and Gale, 2000), relative to pre-Great Moderation years. Results from a VAR model estimated on quarterly data for 1955–2007 are consistent with the hypothesis. This invites a reinterpretation of the Great Moderation. Our methodology may help understand when a credit boom turns into a credit bubble, and contributes to the development of methods of measuring financial fragility. |
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| Keywords: | Financial fragility Great Moderation Credit Output VAR |
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