Credit Cycles, fiscal policy, and global imbalances

Abstract

We use a two-country model with financial frictions and fiscal policy to study the role that changes in credit and fiscal positions play in explaining current account fluctuations. We estimate the model using data for the U.S. and a “rest-of-the-world” aggregate. We find that about 32 percent of U.S. current account balance fluctuations are due to domestic credit shocks, while fiscal shocks explain about 21 percent. Simple macroprudential rules that react to domestic credit conditions and countercyclical fiscal policy can help reduce global imbalances, and lead to a smaller and less volatile U.S. current account deficit.