DP8386 Credit Conditions and the Real Economy: The Elephant in the Room

Author(s): John Muellbauer, David M Williams
Publication Date: May 2011
Keyword(s): Consumption, credit conditions, house prices, wealth
JEL(s): E02, E21, E44, G21, R31
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8386

Changes in credit market architecture are an important but unobservable structural influence on economic activity. For Australian data, we model non-price credit supply conditions within equilibrium correction models of consumption, house prices, mortgage credit and housing equity withdrawal. Our "latent interactive variable equation system" (LIVES) employs a single latent variable to capture evolutionary shifts (in credit conditions) that affect not only the intercept of each equation, but also interact with key economic variables. We show that credit conditions impact on consumption by: (i) lowering the mortgage downpayment constraint facing young households; (ii) introducing a housing collateral channel from house prices to real activity; and (iii) facilitating intertemporal consumption smoothing.