The Influence of Credit Growth on Output Growth in Iceland: A VEC Model Approach

Abstract: In this thesis we used a Vector Error Correction (VEC) model to analyse whether changes in credit growth have a significant effect on output in Iceland using monthly data for the period 1997-2017. Both our results from the error variance decompositions and the impulse response functions suggest that changes in credit and exports have a large impact on Icelandic output. We conclude that changes in credit activity do affect Icelandic macroeconomic variables. There is a statistically significant relationship between output and credit growth and hence the ‘credit view’ is supported in the case of Iceland. This highlights the importance of implementing macroprudential rules that can minimize severe economic fluctuations caused by excessive credit growth.