The Credit Composition of Global Liquidity

Abstract

We conceptualize global liquidity as global monetary policy and credit components by means of a large-scale dynamic factor model. Going beyond previous work, we de- compose aggregate credit components into credit supply and demand flows directed at businesses, households and governments. We show that this decomposition enhances the understanding of global liquidity considerably. In particular, we find that our global credit estimates explain substantial variance shares of a large panel of international financial ag- gregates. Moreover, we extensively document that the prevalence of sectoral credit shocks varies across the financial cycle, characterized by financial sector risk and risk aversion. For instance, whereas household credit supply is high during financial cycle upswings, government credit supply increases in response to adverse shocks to the financial cycle. Moreover, the government sector demands credit in times of bust-episodes, whereas pri- vate entities demand credit in times of booms. To rationalize our findings, we suggest for instance that, whereas global government sector credit supply is best understood as a safe-haven lending factor from an investors perspective, lenders supply businesses and households with credit to maximize profits along the financial cycle.