By Chris Kubelec of the Bank's International Finance Division and Bjorn-Erik Orskaug and Misa Tanaka of the Bank's International Economic Analysis Division.
This article investigates the implications of the size and structure of external balance sheets for the impact of shocks on domestic economies. Increased integration of international financial markets in recent years, coupled with larger international cross-holdings of assets and liabilities, has made the balance sheet channel of transmission of shocks grow in importance. This article constructs detailed decompositions of the balance sheets of the United Kingdom, the United States and Canada. These are used to illustrate what different features of balance sheets imply about the effects on domestic economies from different shocks. Finally, the impact on UK and US external balance sheets from some hypothetical scenarios is examined, and some simple rules of thumb are used to draw out the potential implications for consumption behaviour.