The time-varying relationship between credit spreads and employment growth

Abstract

After the global financial crisis, several central banks introduced unconventional monetary policies, such as quantitative easing (QE). If QE increases asset prices, but does not boost the real economy to the same extent, the relationship between credit spreads and employment growth will weaken. This study investigates this issue for the U.S. in a moving-windows framework. Our results suggest that the link between credit spreads and employment growth is lower during bubbles and recessions. We also find that the relationship weakened after the Fed introduced QE.

Does Monetary Policy Affect Income Inequality in the Euro Area?

“…Stock returns are measured as log first differences of stock prices, while corporate bond spreads as a difference between 5-year corporate bond yield and 5-year government bond yield. 26 Bond spreads have a considerable predictive power for economic activity (Gilchrist et al, 2009;Faust et al, 2013;Xu and de Haan, 2018) and are often used as indicators of abnormal returns in financial markets (Krylova, 2016). Monetary easing reduces bond spreads, leading to higher risk tolerance and a search for yield among investors.…”

Credit spread and employment growth – a time-varying relationship?

“…The variance decomposition calls attention to how heteroscedasticity causes time-variation in the strength of relationships, a change that would materialize as changing R 2 in a rolling window analysis. Though my analysis does not typically attribute as much explanatory power to the credit spread as Xu and de Haan (2018), and I formulate the opposite interpretation, the actual content of our analyses is not dissimilar. The strength of the relationship has been time-varying.…”

“…Using financial variables to capture important aspects of macroeconomic relationships is a growing topic in the literature (Chodorow-Reich 2013;Christiano, Motto, and Rostagno 2014;Faust et al 2013). Recently attention has been paid to the potential of time-variation to such relationships (Aastveit, Natvik, and Sola 2017;Karlsson and Österholm 2020;Xu and de Haan 2018). Including time-variation has an intuitive appeal, not least in the wake of the financial crisis and the ensuing low interest rate/low inflation period (Stock and Watson 2012).…”

“…Theoretically, the interest in credit spreads has been motivated as capturing important financial frictions, particularly the supply of credit to constrained firms (Gilchrist and Zakrajšek 2012). Time variation in the relationship between credit spreads and employment was recently addressed in a paper by Xu and de Haan (2018). In a rolling window regression framework, they concluded that the strength of the relationship has been time-varying.…”

The Financial Accelerator in the Euro Area: New Evidence Using a Mixture VAR Model

“…Akinci and Queralto (2020) show that credit spreads are not only countercyclical, but the strength of their countercyclicality is higher when these are elevated. The results of Xu and de Haan (2018) suggest that the relationship between credit spreads and future employment growth is lower during bubbles and recessions. Finally, Bijsterbosch and Falagiarda (2015) find that the effects of credit supply shocks on the euro area strongly increased at the time the GFC erupted.…”