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The Role of Expectations in Sudden Stops

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  • Karel Mertens

Abstract

This paper presents a flexible-price small open economy model with a “peso problem” in productivity states. Agents rationally adjust their beliefs about future productivity growth after the arrival of news. A downward revision of expectations triggers a Sudden Stop, together with large declines in GDP, employment, consumption and investment. There need not be any actual change in productivity growth to generate large fluctuations. Quantitatively, the model goes a long way in matching the 1998 Korean Crisis and subsequent swift recovery.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2007/16.

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Date of creation: 2007
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Handle: RePEc:eui:euiwps:eco2007/16

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Keywords: sudden stops; small open economy; expectations; peso problem;

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Cited by:
  1. Hans-Werner Sinn & John Hassler & Gilles Saint-Paul & Giancarlo Corsetti & Michael P. Devereux & Tim Jenkinson & Jan-Egbert Sturm & Xavier Vives, 2009. "Chapter 2: The Financial Crisis," EEAG Report on the European Economy, CESifo Group Munich, vol. 0, pages 59-122, 02.

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