P aper No. 907 Banks, shadow banks, and business c

6Conclusion

Creditspreadsonhouseholdandbusinessloansmovehandinhand.Thisisimportant becausespreads,ayardstickforlendingconditions,arecloselyintunewiththebusiness cycle.Thispaperoffersatheorythatlinksinvestorsentimenttocreditspreadsviathe nonbankfinancialsector.Inourmodel,shadowbanksoperatealongsidecommercial bankstosecuritizeriskyindividualloansandhenceproducestandardizedasset-backed securities.Investorsperceivethesesecurities,freeofanyidiosyncraticrisk,tobenearly assafeastraditionalbankdeposits,andconsequentlypurchasethem.That,inturn, allowsbankstoexpandlendingbycharginglowerspreads.

Inperiodsofstress,however,the"nearly"qualificationturnsouttobecrucialand theimperfectsubstitutionbetweensecuritiesanddepositsgrowsapparent.Securities suddenlycommandahigherpremium,enoughtocurtailthecapacityofshadowbanks toengageinsecuritization.Thisspillsovertocommercialbanks:nolongerableto offloadpartoftheirportfolioatthesameprice,theyresorttoincreasingspreadson consumersandbusinessesalike.

Howdoesthataffecttherealeconomy?Asspreadsshootup,creditbecomesdearer. Indebtedhouseholdsmustcutbackongoodsandhousingpurchases.Indebtedfirms mustcutbackoncapitalpurchases.Employment,consumptionandinvestmentfall, causingarecession.Thus,adropininvestorconfidence—wecallitamarketsentiment shock—producesstrongandpositivecomovementsamongthemainmacroeconomic variables,creditquantities,andassetprices,aswellascountercyclicalmovementsin householdandbusinesscreditspreads.Theseimplicationsofthemodelcorrespond welltothebehaviorofactualEuropeanbusinessandfinancialcycles.

Weestimateourmodelusingelevenaggregateseriesfortheeuroarea.Wefindthat themarketsentimentshockisthemaindriverofeconomicandfinancialfluctuations sincetheeurozoneexists.Itaccountsparticularlywellforthetworecessionsin2009 and2012.Inaddition,theshockprocesscorrelateswellwithameasureofsystemic stress,apieceofinformationthatwasnotusedintheestimation.Finally,followinga recentmethodologicalcontributionbyAngeletos,Collard,andDellas(2020),weshow thatthedynamicsproducedbythemarketsentimentshockaresimilartothoseimplied byaVAR-basedmainbusiness-cycleshock.

BusinesscyclesinEuropeandtheUnitedStatesarehighlysynchronized.Apromis- ingavenueofresearchwouldbetomodeltheseeconomiesinatwo-countrysetup andstudyhowmarketsentimentshocksthatemanatefromonecountry,saytheUS, propagatetotheothercountrythroughtheirfinanciallinkages.

18