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Balance Sheet Effects, Bailout Guarantees and Financial Crises

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  • MARTIN SCHNEIDER
  • AARON TORNELL

Abstract

This paper provides a model of boom-bust episodes in middle-income countries. It is based on sectoral differences in corporate finance: the nontradables sector is special in that it faces a contract enforceability problem and enjoys bailout guarantees. As a result, currency mismatch and borrowing constraints arise endogenously in that sector. This sectoral asymmetry allows the model to replicate the main features of observed boom-bust episodes. In particular, episodes begin with a lending boom and a real appreciation, peak in a self-fulfilling crisis during which a real depreciation coincides with widespread bankruptcies, and end in a recession and credit crunch. The nontradables sector accounts for most of the volatility in output and credit. Copyright 2004 The Review of Economic Studies Ltd.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal The Review of Economic Studies.

Volume (Year): 71 (2004)
Issue (Month): (07)
Pages: 883-913

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Handle: RePEc:bla:restud:v:71:y:2004:i::p:883-913

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