Sentiment About Business Debt as a Leading Economic Indicator

Understanding the sources and transmission of financial distress in the economy is essential for macroeconomic stabilization policy. For example, policymakers and academics have both pointed to excesses in credit markets — including abnormally low risk premiums, misaligned incentives for risk taking, lax credit standards and excessive borrowing — as the main culprits behind the 2008-09 financial crisis.1 Since then, many questions have emerged regarding the role of credit factors in business-cycle fluctuations. Postwar data for multiple economies suggest that rapid growth in business or household credit and in asset prices are reliable predictors of a financial crisis within the next three years,2 and highlight the key role of corporate debt3 and household debt4 in explaining boom-bust cycles, financial crises and slow macroeconomic recoveries. Using a new statistical model, the 2022 article "Introducing the Credit Market Sentiment Index" — co-authored by several writers of this article (Danilo, Gabriel, Horacio, Francisco and Egon) — estimated a factor summarizing conditions in U.S. credit markets and showed that it is strongly associated with business debt. We refer to this factor as the credit market sentiment index (CMSI).