External Imbalances and Financial Crises

20 Pages Posted: 7 Dec 2012  

Alan M. Taylor

University of California, Davis - Department of Economics; University of Virginia - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: December 2012

Abstract

In broad perspective, there have been essentially two competing views of the global financial crisis, albeit there are some complementarities among them. One view looks across the border: it mainly blames external imbalances, the large-scale mix of unprecedented pattern current account deficits and surpluses which entailed massive and growing net and gross international financial flows in the last decade. The alternative view looks within the border: it finds more fault in the domestic arena of the afflicted countries, attributing the problems to financial systems where risks originated in excessive credit booms in local banks. This paper uses the lens of macroeconomic and financial history to confront these dueling hypotheses with evidence. Of the two, the credit boom explanation stands out as the most plausible predictor of financial crises since the dawn of modern finance capitalism in the late nineteenth century. Historically, we find that global imbalances are not as important as a factor in financial crises as is often perceived, and they have much less correlation with subsequent episodes of financial distress compared to direct indicators like credit drawn from the financial system itself.

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Suggested Citation

Taylor, Alan M., External Imbalances and Financial Crises (December 2012). NBER Working Paper No. w18606. Available at SSRN: https://ssrn.com/abstract=2186334

Alan M. Taylor (Contact Author)

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