The Macroeconomic Relevance of Credit Flows

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Publish Date	14/06/2023
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Introduction

This paper investigates the Macroeconomic Relevance of Credit Flows by analyzing long-run, sector-level data for the United States. The authors (Alexander Herman, Deniz Igan, and Juan Solé) use the U.S. Financial Accounts (formerly known as Flow of Funds) to decompose credit from banks and nonbanks across different sectors over several decades, and study how these flows behave over business cycles, recessions, recoveries, and financial crises. Their central aim is to understand how credit flows link to macroeconomic stability and systemic risk. IDEAS/RePEc+2IMF+2

At its core, the analysis of the Macroeconomic Relevance of Credit Flows shows that bank-based credit and nonbank credit behave very differently over time. The paper argues that to preserve financial stability, policymakers should pay closer attention to sector-specific and type-specific credit flows rather than relying only on broad interest-rate tools.

the Macroeconomic Relevance of Credit Flows

This paper exploits the Financial Accounts of the United States to derive long time series of bank and nonbank credit to different sectors, and to examine the cyclical behavior of these series in relation to (i) the long-term business cycle, (ii) recessions and recoveries, and (iii) systemic financial crises. We find that bank and nonbank credit exhibit different dynamics throughout the business cycle. This diverging cyclical behavior of output and bank and nonbank credit argues for placing greater emphasis on sector-specific macroprudential measures to contain risks to the financial system, rather than using interest rates to address any vulnerabilities. Finally, we examine the role of bank and nonbank credit in the creation of financial interconnections and illustrate a method to conduct macro-financial stability assessments. The 2007–08 financial crisis made poignantly evident that neither policymakers nor the academic community understood the extent of the risks involved in nonbank financial activity, which became of macroeconomic relevance as the crisis unfolded. This painful lesson unleashed a massive research and policy agenda seeking to understand, measure, and (re-) regulate the nonbank sector. Progress has been made in various fronts, ranging from the quantification and monitoring of the nonbank sector to an ongoing important regulatory reform. However, we still know little about the cyclical behavior of credit flows between banks and nonbanks and their relationship with the rest of the economy. In this paper, we use the Financial Accounts (FAs) of the United States (formerly known as the Flow of Funds) to construct measures of credit among all sectors of the economy.

Key Themes and Findings

1. Data and Methodology

To study the Macroeconomic Relevance of Credit Flows, the authors construct long time series of credit from banks (traditional depository institutions) and nonbanks (shadow banking and other financial institutions) to various U.S. economic sectors. IMF+1 They rely on the Financial Accounts to trace how credit expands and contracts in connection with the business cycle, recessions, and systemic financial crises. IMF+1

They also decompose credit at the sectoral level (households, nonfinancial corporates, etc.) and analyze how these credit flows interact with macroeconomic variables, such as GDP, during different phases of the business cycle. This helps them isolate the specific macro-financial role of credit in amplifying or damping economic fluctuations — essentially probing the Macroeconomic Relevance of Credit Flows from a granular perspective.

2. Diverging Behavior of Bank vs. Nonbank Credit

One of the paper’s most important findings on the Macroeconomic Relevance of Credit Flows is the distinct dynamics exhibited by bank and nonbank credit over economic cycles:

Bank credit tends to follow more traditional credit cycles. During expansions, bank lending grows, and during recessions, it contracts significantly. This behavior is closely tied to monetary policy and the traditional banking model.
Nonbank credit, in contrast, shows a different pattern. The growth of nonbank credit is less tightly clustered around recessions and booms in the same way as bank credit. Instead, nonbank credit seems to build up outside of, or independently from, traditional banking cycles.

Because of these different trajectories, the authors argue that the Macroeconomic Relevance of Credit Flows cannot be fully understood without distinguishing between where credit is coming from (banks vs. nonbanks) and where it is going (which sector).

3. Credit Flows and the Business Cycle

The authors explore how changes in credit flows (both bank and nonbank) correspond to U.S. business cycles over time, showing that the Macroeconomic Relevance of Credit Flows is particularly strong in shaping fluctuations:

During systemic financial crises, nonbank credit tends to contract sharply, suggesting that the shadow banking sector is very sensitive to stress, and this contraction can feed into the real economy.
In recoveries, bank credit often recovers more strongly, perhaps because banks are more directly impacted by central bank policies, deposit flows, and regulation.
Over long business cycles, credit flows provide early warning signals: diverging patterns in credit can signal mounting vulnerabilities that are not captured by GDP alone.

This cyclical asymmetry in credit flows underscores the authors’ claim that the Macroeconomic Relevance of Credit Flows is vital for understanding risk buildup in both the financial system and the real economy.

4. Macroprudential Implications

Given the evidence on the Macroeconomic Relevance of Credit Flows, a core policy message of the paper is that macroprudential regulation should be sector-specific and tailored, rather than relying solely on standard interest rate policies:

Because bank and nonbank credit have different cyclical behaviors, macroprudential tools should reflect these differences. For example, capital or liquidity requirements for nonbank credit providers (shadow banking) may need to be stricter to mitigate systemic risk.
Interest-rate policies (monetary policy) alone are not sufficient to control credit buildup in nonbank sectors. The authors argue that tools like counter-cyclical capital buffers, sectoral leverage limits, or specific oversight of nonbank credit providers should be part of the macro-financial toolkit.
Furthermore, the Macroeconomic Relevance of Credit Flows implies that regulators should monitor interconnectedness between sectors (banks and nonbanks), since credit interlinkages can amplify shocks.

5. Credit Flows and Financial Interconnectedness

Another dimension of the paper’s analysis is how the Macroeconomic Relevance of Credit Flows relates to financial interconnections across sectors:

The authors show that credit flows are not just passive reactions to the economy, but active channels that create financial interconnections among sectors. For example, nonbank institutions may rely on funding lines from banks, while households and businesses rely on both bank and nonbank credit.
These linkages mean that stress in one segment (e.g., a nonbank credit crunch) can quickly transmit to others. Thus, the Macroeconomic Relevance of Credit Flows is not just about volume, but also about how these flows structurally tie together the financial system.
By mapping these connections using their long series data, the authors propose a method to conduct macro-financial stability assessments — assessing not only credit growth, but also how credit flows cross between sectors.

6. Relevance during Financial Crises

The paper highlights how the Macroeconomic Relevance of Credit Flows was particularly salient during the 2007–08 global financial crisis:

Nonbank credit experienced a sharp contraction during the crisis, underscoring that shadow banking activities are highly cyclical and exposed to systemic risk. IMF+1
The authors argue that had policymakers paid more attention to nonbank credit flows before the crisis (i.e., recognized their macroeconomic relevance), some vulnerabilities may have been mitigated.
Their framework implies that early warning systems for financial stability should incorporate not only bank credit metrics but also nonbank credit flows to fully capture risk buildups.

7. Method for Macro-Financial Stability Assessment

To operationalize their insights, the authors develop a method for macro-financial stability assessments based on the long series of bank and nonbank credit flows:

Sectoral decomposition: Partition credit into bank vs nonbank, and further by borrowing sector — households, nonfinancial corporates, etc.
Stability monitoring: Track the cyclical behavior of credit flows relative to economic output, to detect build-ups during expansions that could pose risk.
Interconnection mapping: Analyze how credit flows connect different parts of the financial system, illuminating potential channels of contagion.
Macroprudential calibration: Use the insights on sectoral credit behavior to design policy tools tailored to where risk is building (e.g., nonbank leverage constraints).

This structured approach illustrates how the Macroeconomic Relevance of Credit Flows can be embedded into policy frameworks to limit systemic risk.

8. Policy Recommendations Based on Credit Flow Insights

Based on their findings, the authors make several key recommendations to policymakers regarding the Macroeconomic Relevance of Credit Flows:

Adopt sectoral macroprudential tools: Because bank and nonbank credit flows diverge in their cyclical behavior, regulation should differentiate between these sources. Macroprudential policies such as countercyclical capital buffers or leverage limits should be targeted at nonbank institutions as well.
Improve monitoring of nonbank credit: Authorities should enhance data collection and monitoring of nonbank credit flows, to better understand their cyclical dynamics and risk contributions.
Use credit flow indicators in systemic risk surveillance: Central banks and regulators should integrate the analysis of the Macroeconomic Relevance of Credit Flows — via flow-of-funds data — into their early warning systems.
Promote interconnectedness stress-testing: Simulations and stress tests should incorporate the interconnections between different sectors (banks, nonbanks, households, corporates) to assess how shocks can propagate through credit flows.

Conclusion

In sum, this paper offers a rigorous and data-rich examination of the Macroeconomic Relevance of Credit Flows in the U.S. economy. By constructing long-term series of bank and nonbank credit and analyzing their behavior across business cycles, recessions, and crises, the authors highlight several critical insights:

Bank credit and nonbank credit have distinct cyclical dynamics, which means that their macroeconomic relevance differs and must be treated separately.
The Macroeconomic Relevance of Credit Flows lies not only in total volume but in sector-specific patterns that can amplify or dampen macro-financial risk.
Nonbank credit, because of its build-up outside traditional banking cycles, played a major role in the 2007–08 crisis — pointing to systemic vulnerabilities.
Policymakers should therefore rely on sector-targeted macroprudential measures, robust monitoring of credit flows, and macro-financial stress tests that explicitly account for credit interconnections.

Overall, the paper argues that understanding the Macroeconomic Relevance of Credit Flows is essential for modern financial stability frameworks: credit flows are not just passive reflections of the macroeconomy, but active drivers of systemic risk.

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