Nonfinancial sector debt and the U.S. Great Moderation: Evidence from flow-of-funds data

Abstract

In the mid‐1980s, two shifts occurred in the US economy: the strong decline of macroeconomic volatility and the strong increase of borrowing by the nonfi-nancial sector above the level of output growth until 2007. Since access to credit may decrease output fluctuations, we hypothesize that during the Great Moderation borrowing by the nonfinancial sector in excess of gross domestic product (GDP) growth moderated GDP fluctuations. We estimate Generalized Autoregressive Conditional Heteroskedasticity (GARCH) models over 1954– 2008 to measure output growth volatility and run Vector Autoregressive (VAR) models and a counterfactual simulation in order to analyse the relation of credit growth in excess of output growth and output growth volatility.