Rethinking the Credit-Growth Nexus

Abstract

This paper analyzes the credit-growth nexus by shifting the focus from aggregate leverage and credit stocks to new credit flows. Using quarterly data for 12 euro area countries over 2007–24, covering 96 percent of euro area GDP, the analysis shows a robust empirical association between newly granted bank credit and private final domestic demand (PFDD), a close proxy for GDP. A 10 percent increase in new private credit is associated with about 0.5–0.7 percentage points growth in PFDD. In contrast, specifications based on credit stocks or leverage produce unstable or counterintuitive estimates, reflecting measurement biases related to debt repayments and denominator effects. Nothwithstanding the importance of debt levels and leverage for financial stability and through debt service for the economy, the findings suggest that new credit flows appear to provide a more empirically reliable proxy for the macroeconomic role of bank lending.