The Role of Loan Supply Shocks in Pacific Alliance Countries: A TVP-VAR-SV Approach

This paper analyzes the effect of loan supply shocks on the real economic activity of Pacific Alliance countries. The econometric approach is a Time-Varying Parameter VAR with Stochastic Volatility (TVP-VAR-SV), which is identified by sign restrictions. Results of a trace test, t-tests and the Kolmogorov-Smirnov test reveal the existence of significant changes in the distribution of parameters over time, which supports the use of time-varying parameters. The results indicate that loan supply shocks have an important impact on real economic activity in all Pacific Alliance countries: about 1% in Colombia, Mexico, and Peru, and about 0.5% in Chile. Moreover, loan supply shocks have a considerable role in driving business cycle fluctuations, not only in crisis periods, but also in stability periods. Their contribution to GDP growth is higher than that of aggregate supply shocks and as high as that of aggregate demand and monetary policy shocks. The evolution of the impact of loan supply shocks on real economic activity shows evidence of cross-country heterogeneity, reflecting different financial structures among Pacific Alliance countries. Furthermore, by assessing the effects on different measures of economic activity, it is estimated that loan supply shocks have a higher impact on domestic demand, while the impact is similar when the model is estimated for non-primary activities. Finally, the sensitivity analysis indicates that the results of the model are robust to different priors specifications, to different measures of external variables, and to multiple sets of sign restrictions. Moreover, by applying an agnostic identification, the results indicate that even letting the response of GDP unrestricted, its response to loan supply shocks remains positive and significant. With this multiple specification, the impact of loan supply shocks on GDP growth ranges between 0.8% and 1.2% in Peru and Colombia, and between 0.5% and 0.8% in Chile. These results are close to the baseline estimation and show robustness. Regarding Mexico, it is estimated that the impact of loan supply shocks varies between 0.8%-3.5%.

Keywords

Loan Supply Shocks, Variance Decomposition, Historical Decomposition, Time-Varying Parameter VAR with Stochastic Volatility, Sign Restrictions

JEL Classification

C32, E32, E51