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The Credit Channel in Middle Income Countries

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Author Info
Aaron Tornell ()
Frank Westermann ()

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Abstract

With inflation under control in many in middle income countries (MICs), it is now swings in credit, investment and asset prices that affect these countries the most. In this paper we present a framework to analyze both theoretically and empirically how credit market shocks are propagated and amplified in MICs.The strength of the credit channel in our model derives from two key characteristics of MICs: (i)a sharp asymmetry across the tradables (T) sector and the more bank-dependent nontradables (N) sector; and (ii)a significant degree of currency mismatch in the N-sector. This makes movements in the real exchange rate the driving element in the amplification of shocks. The equilibrium imposes unambiguous contemporaneous linkages among key macroeconomic variables and allows us to derive structural VARs. Estimating these VARs using quarterly data for a group of MICs, we find evidence for a strong credit channel, for a balance sheet effect and for asymmetric sectorial responses. Our findings indicate that inflation targeting is not sufficient to guarantee economic stability, as such policy might overlook the development of lending booms and associated sectorial asymmetries.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 832.

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Date of creation: 2003
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Handle: RePEc:ces:ceswps:_832

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Raghuram Rajan & Giovanni Dell'Ariccia & Enrica Detragiache, 2005. "The Real Effect of Banking Crises," IMF Working Papers 05/63, International Monetary Fund. [Downloadable!]
    Other versions:
  2. Nicolas Magud, 2002. "Exchange Rate Regime Choice and Country Characteristics: an Empirical Investigation into the Role of Openness," University of Oregon Economics Department Working Papers 2004-15, University of Oregon Economics Department, revised 20 Oct 2004. [Downloadable!]
  3. Madhavi Bokil, 2005. "Fear of Floating: An optimal discretionary monetary policy analysis," International Finance 0510002, EconWPA. [Downloadable!]
  4. Irina Bunda & Michele Ca’ Zorzi, 2009. "Signals from housing and lending booms," Working Paper Series 1094, European Central Bank. [Downloadable!]
  5. Michael M. Hutchison & Ilan Noy & Lidan Wang, 2007. "Fiscal and Monetary Policies and the Cost of Sudden Stops," Working Papers 200724, University of Hawaii at Manoa, Department of Economics. [Downloadable!]
  6. Almira Buzaushina & Michael Brei, 2009. "Matching International Financial Shocks in Emerging Markets," Bonn Econ Discussion Papers bgse2_2009, University of Bonn, Germany. [Downloadable!]
  7. Nicolas Magud, 2002. "Currency Mismatch, Openness and Exchange Rate Regime Choice," University of Oregon Economics Department Working Papers 2004-14, University of Oregon Economics Department, revised 01 Sep 2004. [Downloadable!]
  8. Michael Hutchison & Ilan Noy, 2004. "Sudden Stops and the Mexican Wave: Currency Crises, Capital Flow Reversals and Output Loss in Emerging Markets," Santa Cruz Department of Economics, Working Paper Series 1009, Department of Economics, UC Santa Cruz. [Downloadable!]
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  9. Yong Sarah Zhou, 2008. "Capital Flows and Economic Fluctuations: The Role of Commercials Banks in Transmitting Shocks," IMF Working Papers 08/12, International Monetary Fund. [Downloadable!]
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