Abstract: This paper evaluates the role of investor risk sentiments in the commercial bank lending market and their effect on macroeconomic outcomes. I create an empirical measure of bank risk sentiment —irrational bank-level shocks to expected loan portfolio default rates— using regulatory data covering the universe of U.S. commercial banks and an identification scheme motivated by a novel, analytical, heterogeneous bank model. Aggregate bank risk sentiment (BRS) is pessimistic during financial crises and optimistic during debt-fueled asset bubbles, but is heterogeneous at the bank-level. BRS shocks act like credit supply shocks, impacting both the extensive and intensive margins of lending. Through lending markets, a pessimistic sentiment shock leads to a significant and long-lived deterioration in economic activity and prices, prompting a monetary policy easing. I also show that BRS is equally or more important in explaining macroeconomic outcomes than corporate bond market sentiment shocks (proxied by fluctuations in the Excess Bond Premium), real shocks (including generic aggregate demand and supply shocks), and U.S. monetary policy shocks. I lastly turn to a loan-level analysis to explore the potential micro-to-macro transmission mechanisms of bank-level sentiment shocks, and show that pessimistic sentiment shocks tighten earning base borrowing constraints.
Coauthored with Elijah Broadbent, Huberto Ennis, and Horacio Sapriza
Abstract: The provision of bank credit to firms and households affects macroeconomic performance. We use survey measures of changes in bank lending standards, disaggregated by loan category, to quantify the effect of changes in banks’ attitudes toward lending on aggregate output, inflation, and interest rates. Bank lending to businesses is particularly important for macroeconomic outcomes, with peak effects on output of around half a percentage point after four quarters of the initial shock. These effects depend on the stage of the business cycle and the proximity of the short-term interest rate to its effective lower bound. The effects are larger when output is growing below trend and when the interest rate is away from its lower bound. We also find that the response of the economy to lending-standards shocks is asymmetric, with tightening shocks having larger effects on output.
Coauthored with Andrea Ajello