Credit Cycles, Fiscal Policy, and Global Imbalances

IMF Working Papers, February 19, 2021

Source details

The paper studies the role that changes in credit and fiscal positions play in explaining current account fluctuations.
Empirical finding: the current account declines when credit increases, and when the fiscal balance declines.
Method: a two-country model with financial frictions and fiscal policy is estimated using annual data for the U.S. and a “rest of the world” aggregate that includes main advanced economies.
Key quantitative attributions: about 30 percent of U.S. current account balance fluctuations are due to domestic credit shocks, while fiscal shocks explain about 14 percent.

Current account movements are negatively associated with increases in credit.
Current account movements are negatively associated with declines in the fiscal balance.
Quantified contributions to U.S. current account balance fluctuations:
- Domestic credit shocks: about 30 percent.
- Fiscal shocks: about 14 percent.

Framework: two-country general equilibrium model with financial frictions and explicit fiscal policy.
Data: annual data for the U.S. and a “rest of the world” aggregate that includes main advanced economies.
Objective: reconcile empirical correlations between credit, fiscal balances, and current account fluctuations within the calibrated/estimated model.

Macroprudential policy rules:
- Simple macroprudential rules that react to domestic credit conditions or to domestic house prices help reduce global imbalances.
- By taming the financial cycle, such macroprudential rules would have led to a smaller and less volatile U.S. current account deficit.
Fiscal policy:
- A countercyclical fiscal policy rule that stabilizes output growth reduces both the level and volatility of the U.S. current account deficit.