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Financial Sector Ups and Downs and the Real Sector: Up by the Stairs and Down by the Parachute

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  • Aizenman, Joshua
  • Pinto, Brian
  • Sushko, Vladyslav

Abstract

This paper examines how financial expansion and contraction cycles affect the broader economy throughtheir impact on eight real economic sectors in a panel of 28 countries over 1960-2005, paying particularattention to large, or sharp, contractions and magnifying and mitigating factors. We find that abruptfinancial contractions are more likely to follow periods of accelerated growth, indicative of ‘up by thestairs, down by the parachute’ dynamics. Sharp fluctuations in the financial sector have asymmetriceffects, with the majority of real sectors adversely affected by contractions but not helped by expansions.The adverse effects of financial contractions are transmitted almost exclusively by the financial opennesschannel with foreign reserves mitigating these effects with a sizeable (10 to 15 times greater) impactduring sharp financial contractions. Both effects are magnified during particularly large financialcontractions (with coefficients on interaction terms two to three times greater than when all contractionsare considered). Consequent upon a financial contraction, the most severe real sector contractions occur incountries with high financial openness; relative predominance of construction, manufacturing, andwholesale and retail sectors; and low international reserves.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt81p0j667.

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Date of creation: 10 May 2012
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Handle: RePEc:cdl:ucscec:qt81p0j667

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Keywords: Social and Behavioral Sciences; financial cycles; financial and trade openness; real transmission of financial shocks; reserves;

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References

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  1. Guillermo A. Calvo & Alejandro Izquierdo & Luis Fernando Mejía, 2004. "On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects," IDB Publications 6516, Inter-American Development Bank.
  2. Joshua Aizenman & Jaewoo Lee, 2005. "International reserves: precautionary versus mercantilist views, theory and evidence," Proceedings, Federal Reserve Bank of San Francisco.
  3. Marcel P. Timmer & Gaaitzen J. de Vries, 2009. "Structural change and growth accelerations in Asia and Latin America: a new sectoral data set," Cliometrica, Journal of Historical Economics and Econometric History, Association Française de Cliométrie (AFC), vol. 3(2), pages 165-190, June.
  4. Aizenman, Joshua & Pinto, Brian, 2011. "Managing financial integration and capital mobility -- policy lessons from the past two decades," Policy Research Working Paper Series 5786, The World Bank.
  5. Reinhart, Carmen & Calvo, Guillermo, 2000. "When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options," MPRA Paper 6982, University Library of Munich, Germany.
  6. Clemente, Jesus & Montanes, Antonio & Reyes, Marcelo, 1998. "Testing for a unit root in variables with a double change in the mean," Economics Letters, Elsevier, vol. 59(2), pages 175-182, May.
  7. James H. Stock & Mark W. Watson, 2003. "Has the Business Cycle Changed and Why?," NBER Chapters, in: NBER Macroeconomics Annual 2002, Volume 17, pages 159-230 National Bureau of Economic Research, Inc.
  8. McMillan, Margaret & Rodrik, Dani, 2012. "Globalization, structural change, and productivity growth:," IFPRI discussion papers 1160, International Food Policy Research Institute (IFPRI).
  9. Aizenman, Joshua & Pinto, Brian, 2011. "Managing Financial Integration and Capital Mobility— Policy lessons from the past two decades," Santa Cruz Department of Economics, Working Paper Series qt9j53m1tp, Department of Economics, UC Santa Cruz.
  10. M. Kabir Hassan & Jung Suk-Yu, 2007. "Financial Development and Economic Growth: New Evidence from Panel Data," NFI Working Papers 2007-WP-10, Indiana State University, Scott College of Business, Networks Financial Institute.
  11. Joshua Aizenman & Vladyslav Sushko, 2011. "Capital flows: Catalyst or Hindrance to economic takeoffs?," NBER Working Papers 17258, National Bureau of Economic Research, Inc.
  12. Kenneth French & Martin Baily & John Campbell & John Cochrane & Douglas Diamond & Darrell Duffie & Anil Kashyap & Frederic Mishkin & Raghuram Rajan & David Scharfstein & Robert Shiller & Hyun Song Shi, 2010. "The Squam Lake Report: Fixing the Financial System," Journal of Applied Corporate Finance, Morgan Stanley, vol. 22(3), pages 8-21.
  13. Cardarelli, Roberto & Elekdag, Selim & Lall, Subir, 2011. "Financial stress and economic contractions," Journal of Financial Stability, Elsevier, vol. 7(2), pages 78-97, June.
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Cited by:
  1. Phakawa Jeasakul & Cheng Hoon Lim & Erik J. Lundbäck, 2014. "Why Was Asia Resilient? Lessons from the Past and for the Future," IMF Working Papers 14/38, International Monetary Fund.

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