6. Concluding remarks
Berger and Bouwman (2009) propose a measure of bank liquidity creation that factors in both banks’ on- and off-balance sheet activities since banks create liquidity on the balance sheet and off the balance sheet. While measuring bank liquidity creation is important, investigating its impact on economic growth is central to evaluate the efficacy of monetary policy. There is an extensive literature on the relationship between the term spread and recessions (e.g., Estrella and Hardouvelis, 1991; Estrella and Mishkin, 1998), but the relationship between bank liquidity creation and recessions, to the best of our knowledge, has not been investigated in the literature. We examine this particular issue in this study by augmenting the term spread model of Estrella and Hardouvelis (1991) with bank liquidity creation measures of Berger and Bouwman (2009). We show that bank liquidity creation measures, especially on-balance sheet liquidity creation, contain information about future recessions for up to four quarters into the future. We also provide an additional potential explanation for the severity of the 2007–2009 recession. Thakor (2005) argues that when credits are difficult to obtain, banks provide their long-standing customers with pre-arranged off-balance sheet credit rights such as standby letters of credit. We find an empirical support for this line of argument for the 1984–2002 subsample, which includes two recessions. However, when we investigate the last recession, we find evidence that banks created lower off-balance sheet liquidity prior to the recent crisis. Bank offbalance sheet liquidity creation data show that during the prior four quarters (2006:Q4–2007:Q3) before the recent recession (2007:Q4–2009:Q2), the mean of bank off-balance sheet liquidity creation growth was 1.64% per quarter, while the average for the same for the prior two recessions (1990 and 2001 recessions) was 4.08% per quarter. This may explain why the recent recession has been longer and more severe.
