Accounting for the business cycle reduces the estimated losses from systemic banking crises

Abstract

We re-estimate the effects of systemic banking crises in industrialised countries reported by Cerra and Saxena (Am Econ Rev 98(1):439-457, 2008) with a model that includes transitory business cycle shocks. We use the correlation between countries' business cycles to identify temporary business cycle shocks, which helps prevent these transitory shocks being incorrectly explained by the crisis dummy. Doing so results in estimated permanent losses from systemic banking crises of 4% rather than the 6% reported in the original article. In contrast, accounting for the business cycle has no effect on the estimated losses from currency and debt crises. These typically occur when the crisis country becomes sufficiently uncorrelated with the country to which it has tied itself, so accounting for the cross-correlation in business cycles does not improve the counterfactual of what would have happened without a crisis.

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