International Bank Flows and the Global Financial Cycle

What is the role for supply and demand forces in determining movements in international banking flows? And what role might a common factor-the global financial cycle highlighted by Rey (Dilemma not trilemma: the global financial cycle and monetary policy independence, 2018) and others-play in movements in these flows? Answering these questions is crucial for understanding the international transmission of financial shocks and formulating policy. This paper addresses them by using the method developed in Amiti and Weinstein (J Polit Econ 126(2):525-587, 2018) to exactly decompose the growth in international bank credit into common shocks, idiosyncratic supply shocks and idiosyncratic demand shocks for the period 2000-2017. A striking feature of the global banking flows data can be characterized by what we term the "Anna Karenina Principle": all healthy credit relationships are alike, and each unhealthy credit relationship is unhealthy in its own way. During non-crisis years, bank flows are well explained by a common global factor. But during times of crisis, flows are affected by idiosyncratic demand shocks to borrower countries and by supply shocks to their creditor banks. That is, the importance of the common component seems to vary over time. This has important implications for why standard econometric models break down during crises.