External Debt in Emerging Economies: A Macrodynamical Model of Financial Fragility
AbstractFollowing both the balance-sheet approach to currency crises and the financial fragility literature, the paper presents an open economy macrodynamical monetary growth model with the aim of giving an endogenous characterisation to the process that, over time, leads an emerging economy to accumulate dangerously high levels of debt and to be vulnerable to macroeconomic instability. The model explores the nonlinear real and financial interaction at work, with the endogenously generated liquidity feeding back dynamically to firmsÃ¢â¬â¢ investment, the level of output, the interest rate and the expected rate of return. The paper shows that the system may display instability if lenders and borrowers are not too concerned with firmsÃ¢â¬â¢ degree of leverage, profitability expectations do not take adequately into account firmsÃ¢â¬â¢ financial structure, and destabilising feedback mechanisms dominate, which go from debt accumulation and profitability expectations onto the rate of profit and the interest rate. As a result, the economy may incur in excessive foreign borrowing. The consequent worsening in firmsÃ¢â¬â¢ balance sheets may turn into financial fragility, and over time bring about a fall in external lending. A prolonged recession may thus follow, possibly calling into question the currency arrangements; hence, a financial crisis may turn into a currency crisis.
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Bibliographic InfoArticle provided by FrancoAngeli Editore in its journal STUDI ECONOMICI.
Volume (Year): 2004/84 (2004)
Issue (Month): 84 ()
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Other versions of this item:
- Eleonora Cavallaro & Marcella Mulino, 2002. "External debt in emerging economies: a macrodynamical model of financial fragility," Working Papers 68, University of Rome La Sapienza, Department of Public Economics.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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- Barry Eichengreen & Ricardo Hausmann & Ugo Panizza, 2007. "Currency Mismatches, Debt Intolerance, and the Original Sin: Why They Are Not the Same and Why It Matters," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 121-170 National Bureau of Economic Research, Inc.
- Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000.
"Balance Sheets and Exchange Rate Policy,"
NBER Working Papers
7840, National Bureau of Economic Research, Inc.
- Mulino, Marcella, 2002. "Currency boards, credibility and crises," Economic Systems, Elsevier, vol. 26(4), pages 381-386, December.
- Gatti, D. Delli & Gallegati, M. & Gardini, L., 1993. "Investment confidence, corporate debt and income fluctuations," Journal of Economic Behavior & Organization, Elsevier, vol. 22(2), pages 161-187, October.
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