Accelerate or brake?—The connection of credit gaps and economic disequilibrium

Abstract

Credit supply shocks significantly aggravate the impact of economic recessions. Understanding the underlying reasons why credit market shocks occur and detecting the market turbulences in time can give a decision support tool for the economic policy to intervene more efficiently on the market and to reduce the effect of economic downturns. The goal of the current article is to investigate the factors that signal possible credit shocks by analyzing the quarterly data of 17 European countries over the period 1995–2021. The focus of the article is on the credit given to the nonfinancial corporations. In our analysis, we have built on the credit gap methodology by determining the deviations of the lending activity from its trend, and then we have modeled these credit gaps using fundamental macroeconomic indicators, such as the balance of the current account, the ratio of short‐ and long‐term capital investments and government debt. Our conclusion is that in the presence of fundamental disequilibrium in the economy excessive lending creates positive credit gaps that increase the chance of negative credit market shocks. According to our new findings, the existing credit gap methodology can be improved by incorporating real economic factors; slowing long‐term capital investment and increasing the deficit of the current account signal the emergence of a credit gap. We found significant regional heterogeneity as in Southern European countries, and the credit gaps were more substantial. Among the investigated macroeconomic factors, the governmental indebtedness was especially high in these countries suggesting that countries with high public debt rates are more prone to develop credit gaps.