The Impact of Credit Market Sentiment Shocks

Abstract

This paper investigates the role of credit market sentiment and investor beliefs in credit cycle dynamics and their transmission to businesscycle fluctuations. Using U.S. data from 1968 to 2014, we find that credit market sentiment is indeed able to detect asymmetries in a small-scale macroeconomic model. An unexpected credit market sentiment shock has different impacts in an optimistic and pessimistic credit market environment. While an unexpected movement in the optimistic regime leads to a rather muted impact on output and credit, we find a significant negative impact on these variables in the pessimistic regime. The findings highlight the relevance of expectation formation mechanisms as a source of macroeconomic instability.