Bank Liquidity Creation and Recessions

Abstract

We investigate the relationship between bank liquidity creation and recessions in the U.S. For the 1984-2010 sample, we find that (i) lower bank on-balance sheet liquidity creation signals recessions four quarters into the future; (ii) off-balance sheet liquidity creation is not a robust predictor of recessions at longer forecast horizons; (iii) off-balance sheet liquidity creation falls in tandem with on-balance sheet liquidity creation one quarter prior to recessions, and aggregate, on- and off-balance sheet bank liquidity creation continue to decline during and up to five quarters after recessions; (iv) liquidity creation of larger banks contains more information about future recessions than that of smaller ones.

Keywords: Treasury Yield Curve, Bank Liquidity Creation, Recessions, Monetary Policy

JEL Classification: E43, E47, E52, E58, G17