Does the Income Balance Stabilize the Current Account During Crises?

The net income balance (IB) is comparable to the trade balance (TB) for many countries yet the role of the IB in mitigating external vulnerabilities or complicating external adjustment is underexplored. This paper studies the role of the IB in stabilizing or destabilizing the current account in crises. We find that the IB generally does not improve during crisis episodes, so current account adjustment occurs entirely through improvements in the TB. These findings are more robust in advanced and emerging market economies than in low‐income economies. However, delving into components of the IB, we find that FDI and other equity income start to improve on the eve of the crisis and there is some evidence that secondary income might help the income balance improve in low‐income countries. Our analysis uses a comprehensive crisis database and pioneering application of a heterogeneity‐robust treatment effects estimator that is likely useful in a wide range of empirical macroeconomic settings.