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Studying the Effects of Household and Firm Credit on the Trade Balance: The Allocation of Funds Matters

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Berrak Buyukkarabacak ()
Stefan Krause ()

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Abstract

One of the most widely used indicators of financial development in the empirical literature is the Private Credit to GDP ratio. A key shortcoming of this measure is that it does not distinguish between the share of credit extended to households vis-à-vis firms. It is our contention that this distinction is crucial to analyze the effects of financial development on the trade balance: Changes in the composition of private credit should have an impact on the foreign trade deficit. Our empirical findings show that: 1) private credit to households is negatively and significantly correlated with net exports; 2) private credit to firms is not significantly correlated with net exports; and 3) the allocation of credit matters; a higher proportion of firm credit is positively and significantly correlated with net exports. A key implication of these results is that, whenever there is a sizeable trade deficit or a high risk of a currency crisis, policy makers should limit the growth of household credit while, at the same time, encourage further allocation of funds to firms.

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Paper provided by Department of Economics, Emory University (Atlanta) in its series Emory Economics with number 0510.

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Date of creation: Feb 2005
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Handle: RePEc:emo:wp2003:0510

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