Emerging Market Cycles: Twin-Balance Sheet Conditions and Macro- Financial Linkages

Soumya Bhadury, Bhanu Pratap and Jay Surti

No 2025/216, IMF Working Papers from International Monetary Fund

Abstract: This paper empirically examines the dynamic linkages between financial conditions and economic growth across 18 major emerging market economies over the last two decades and the role that fiscal and trade balances play in shaping such associations. Using a reduced-form multivariate autoregressive state-space model, we document two opposing forces – growth-enhancing and growth-inhibiting linkages – that characterize macro-financial dynamics in these countries. Easing of domestic financial conditions is associated with stronger near-term GDP growth, a growth-enhancing link, albeit this acceleration in growth is followed by a tightening of financial conditions that can adversely impact future growth outcomes, a growth-inhibiting link. Both linkages are statistically significant at high frequencies for nearly half of the countries in our sample and appear to be driven by a weak twin-balance sheets condition of high public debt and external imbalances. External factors, notably the global financial cycle, are shown to play a crucial role in amplifying this feedback loop between economic growth and financial conditions.

Keywords: Macro-financial linkages; emerging markets; twin-deficits; financial conditions; MARSS model; Kalman filter; IMF working papers; twin-balance sheet condition; emerging market cycle; macro-Financial linkage; model coefficient; Emerging and frontier financial markets; Current account; Financial conditions index; Financial statements; Current account deficits; Global (search for similar items in EconPapers)
Pages: 50
Date: 2025-10-24
New Economics Papers: this item is included in nep-fdg, nep-ifn and nep-inv
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