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Sudden Stops, Financial Crises, and Leverage

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  • Enrique G. Mendoza

Abstract

Financial crashes were followed by deep recessions in the Sudden Stops of emerging economies. An equilibrium business cycle model with a collateral constraint explains this phenomenon as a result of the amplification and asymmetry that the constraint induces in the responses of macro-aggregates to shocks. Leverage rises during expansions, and when it rises enough it triggers the constraint, causing a Fisherian deflation that reduces credit and the price and quantity of collateral assets. Output and factor allocations fall because access to working capital financing is also reduced. Precautionary saving makes Sudden Stops low probability events nested within normal cycles, as observed in the data. (JEL E21, E23, E32, E44, G01, O11, O16)

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 100 (2010)
Issue (Month): 5 (December)
Pages: 1941-66

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Handle: RePEc:aea:aecrev:v:100:y:2010:i:5:p:1941-66

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  1. Fabio Braggion & Lawrence J. Christiano & Jorge Roldos, 2007. "Optimal Monetary Policy in a 'Sudden Stop'," NBER Working Papers 13254, National Bureau of Economic Research, Inc.
  2. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  3. Ceyhun Bora Durdu & Enrique G. Mendoza & Marco E. Terrones, 2007. "Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Merchantilism," NBER Working Papers 13123, National Bureau of Economic Research, Inc.
  4. Philippe Martin & Hélène Rey, 2006. "Globalization and Emerging Markets: With or Without Crash?," Sciences Po publications info:hdl:2441/9261, Sciences Po.
  5. Javier García-Cicco & Roberto Pancrazi & Martín Uribe, 2006. "Real Business Cycles in Emerging Countries?," NBER Working Papers 12629, National Bureau of Economic Research, Inc.
  6. David Cook & Woon Gyu Choi, 2002. "Liability Dollarization and the Bank Balance Sheet Channel," IMF Working Papers 02/141, International Monetary Fund.
  7. Mendoza, Enrique G. & Smith, Katherine A., 2006. "Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices," Journal of International Economics, Elsevier, vol. 70(1), pages 82-114, September.
  8. Enrique G. Mandoza & Vivian Z. Yue, 2008. "A solution to the default risk-business cycle disconnect," International Finance Discussion Papers 924, Board of Governors of the Federal Reserve System (U.S.).
  9. Meza Felipe & Quintin Erwan, 2007. "Factor Utilization and the Real Impact of Financial Crises," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-41, September.
  10. Martin Uribe & Vivian Z. Yue, 2003. "Country Spreads and Emerging Countries: Who Drives Whom?," NBER Working Papers 10018, National Bureau of Economic Research, Inc.
  11. Calvo, Guillermo A. & Izquierdo, Alejandro & Loo-Kung, Rudy, 2006. "Relative price volatility under Sudden Stops: The relevance of balance sheet effects," Journal of International Economics, Elsevier, vol. 69(1), pages 231-254, June.
  12. Gian Maria Milesi Ferretti & Assaf Razin, 2000. "Current Account Reversals and Currency Crises: Empirical Regularities," NBER Chapters, in: Currency Crises, pages 285-323 National Bureau of Economic Research, Inc.
  13. Pablo Andres Neumeyer & Fabrizio Perri, 1999. "Business Cycles in Emerging Economies: the role of interest rates," Department of Economics Working Papers 014, Universidad Torcuato Di Tella.
  14. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2001. "External constraints on monetary policy and the financial accelerator," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  15. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  16. Roberto Garcia-Saltos & Leonardo Auernheimer, 2000. "International Debt and the Price of Domestic Assets," IMF Working Papers 00/177, International Monetary Fund.
  17. Gopinath, Gita, 2004. "Lending booms, sharp reversals and real exchange rate dynamics," Journal of International Economics, Elsevier, vol. 62(1), pages 1-23, January.
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