Current Account Imbalances, Income Inequality, and Financial Instability: Asian Experiences

Abstract

ABSTRACT From Asian experiences in financial crises of 1997–08 and 2007–09, this study finds that higher income inequality can worsen current account imbalances and exacerbate external vulnerability. Capital flows, volatile though they are, are the effect, not the cause, of variations in economic fundamentals. We show that credit-based growth with the aid of foreign financing is prone to financial fragility while export-oriented growth on the basis of domestic saving is good for financial stability. Given the rising international political tensions, our result suggests that Asian emerging markets should reduce inequality and boost demand to achieve sustainable credit and balanced growth. By doing so, Asia can effectively help alleviate global imbalances and lower financial risk.