Economic Activity and Credit Market Linkages: New Evidence From Italy

We investigate the interactions between the business cycle and credit markets in Italy, focusing on how macroeconomic shocks affect the banking sector (i.e. the real effect) and in turn how the financial system’s reaction influences the economic activity (i.e. the feedback effect). We find evidence of both effects, with the former conveyed primarily by the creditworthiness of large firms. Moreover, using data from the Bank Lending Survey provided by the ECB, we disentangle credit supply shocks due to factors inside the banking sector (the bank lending channel), from those outside the banking sector (the borrower’s balance-sheet channel), finding that both types of shocks have a significant impact on the real economy. Our results have far reaching implications for financial stability.