Quantifying the Macroeconomic Impact of Credit Expansions

ABSTRACT Credit expansions stimulate the economy. We quantify the contribution of households versus firms for this stimulus. Using causal evidence from the quasi‐natural experiment of bank deregulation across US states, we estimate a small open‐economy heterogeneous‐agent New Keynesian model. Deregulation generated lower borrowing costs. Firms' responses to such shocks account for most of the long‐run rise in output and employment. For short‐run dynamics, firms and households are equally important. Firms' large role is identified by an empirical observation: output and employment expanded gradually following deregulation. In the model, lower interest rates generate increasing capital stocks which in turn increases economic activity gradually.