Agenda

Eddie Gerba, Bank of England, will present: When credit booms become troublesome: The role of investor sentiment

Abstract

Identifying the underlying driver of credit cycles is crucial for macroprudential regulation. We show in a macro-finance model that investor sentiments lead to excessive asset price movements, which generate credit booms that result in sharp reversals. Motivated by this model, we decompose fluctuations in stock prices into fundamental and noise shocks, and estimate the impulse responses of credit to those shocks. Both shocks lead to a credit expansion, but only a noise shock results in a reversal if the anticipated shock fails to realize. We identify a bank lending channel and a market lending channel as important for the propagation of noise shocks. Financial amplification matters: we show that the impact of noise shocks on credit and the real economy is larger during times of low risk premiums