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Credit booms, banking crises, and the current account

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  • J. Scott Davis
  • Adrienne Mack
  • Wesley Phoa
  • Anne Vandenabeele

Abstract

What is the marginal effect of an increase in the private sector debt-to-GDP ratio on the probability of a banking crisis? This paper shows that the marginal effect of rising debt levels depends on an economy's external position. When the current account is in surplus or in balance, the marginal effect of an increase in debt is rather small; a 10 percentage point increase in the private sector debt-to-GDP ratio increases the probability of a crisis by about 1 to 2 percentage points. However, when the economy is running a sizable current account deficit, implying that any increase in the debt ratio is financed through foreign borrowing, this marginal effect can be large. When a country has a current account deficit of 10% of GDP (which is similar to the value in the Eurozone periphery on the eve of the recent crisis) a 10 percentage point increase in the private sector debt ratio leads to a 10 percentage point increase in the probability of a crisis.

Suggested Citation

  • J. Scott Davis & Adrienne Mack & Wesley Phoa & Anne Vandenabeele, 2014. "Credit booms, banking crises, and the current account," Globalization Institute Working Papers 178, Federal Reserve Bank of Dallas.
    • Handle: RePEc:fip:feddgw:178
    DOI: 10.24149/gwp178
    Note: Published as: Davis, J. Scott, Adrienne Mack, Wesley Phoa and Anne Vandenabeele (2016), "Credit Booms, Banking Crises, and the Current Account," Journal of International Money and Finance 60: 360-377.
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    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G01 - Financial Economics - - General - - - Financial Crises

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