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Credit booms, banking crises, and the current account

  • Davis, J. Scott

    ()

    (Federal Reserve Bank of Dallas)

  • Mack, Adrienne

    (Federal Reserve Bank of Dallas)

  • Phoa, Wesley

    (The Capital Group Companies)

  • Vandenabeele, Anne

    (The Capital Group Companies)

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.

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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 178.

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Length: 33 pages
Date of creation: 13 May 2014
Date of revision:
Handle: RePEc:fip:feddgw:178
Contact details of provider: Web page: http://www.dallasfed.org/
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