When Two Become One: Foreign Capital and Household Credit Expansion

52 Pages Posted: 6 Apr 2021 Last revised: 18 Aug 2021

See all articles by Lukas Diebold

Lukas Diebold

University of Mannheim

Björn Richter

Universitat Pompeu Fabra; Barcelona Graduate School of Economics (Barcelona GSE)

Date Written: April 1, 2021

Abstract

We employ data from financial accounts for 31 countries to trace the flow of financial capital through the economy and identify the ultimate sources of funds behind credit expansions. Removing the veil of financial intermediation reveals that foreign capital has financed most of the secular increase in credit-to-GDP ratios between 1980 and today. In the medium term, household credit financed with foreign capital is the crucial link between credit expansions and future economic performance. An increase in household credit financed from abroad is associated with a contemporaneous reallocation from the tradable to the non-tradable sector, and it predicts lower output and higher unemployment over the following years. Foreign-financed household credit expansion also predicts low returns on bank equities and housing. On the other hand, domestically financed credit neither predicts business cycle dynamics nor returns. Furthermore, household credit financed from abroad is a robust predictor of financial crises and the flight of foreign capital is the major force behind low credit growth after crises.

Keywords: Credit cycles, capital flows, business cycles, financial crises

JEL Classification: E44, F34, G01, G15

Suggested Citation

Diebold, Lukas and Richter, Björn, When Two Become One: Foreign Capital and Household Credit Expansion (April 1, 2021). Available at SSRN: https://ssrn.com/abstract=3817595 or http://dx.doi.org/10.2139/ssrn.3817595

Lukas Diebold

University of Mannheim ( email )

Chair of Economic History
Mannheim, 68131
Germany

Björn Richter (Contact Author)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, E-08005
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

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