The real effects of liquidity on behavior: evidence from regulation and deregulation of credit markets

Economies around the world are marked by major interventions in credit markets. Institutions ranging from central banks to the Grameen Bank operate under the assumptions that credit markets are imperfect, that these imperfections can be ameliorated, and that doing so increases output. There is surprisingly little empirical support for these propositions. Chapters 1 and 2 develop evidence on related questions by exploiting changes to a major intervention in U.S. credit markets, the Community Reinvestment Act (CRA). Using data on both banks and potential commercial borrowers, Chapter 1 develops evidence that CRA does increase credit to small businesses as intended. Chapter 2 then exploits these CRA-induced supply shocks to identify the impact of credit increases on county-level payroll and bankruptcies. There is some evidence of real benefits at plausible implied rates of return on CRA borrowing, and little suggestion of crowd-out or adverse effects on bank performance. The findings therefore appear consistent with a model where targeted credit market interventions can improve efficiency, although important questions remain. Despite a growing number of studies concluding that a substantial proportion of US households are liquidity constrained, there remains little consensus as to the quantitative importance or nature of these constraints. This paper develops a new type of evidence on the impacts of consumer credit markets on behavior by examining household-level responses to an exogenous liquidity shock.