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Financial Frictions and Total Factor Productivity: Accounting for the Real Effects of Financial Crises

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Abstract

The financial crises or “sudden stops” of the last decade in emerging economies were accompanied by a large fall in total factor productivity. In this paper we explore the role of financial frictions in exacerbating the misallocation of resources and explaining this drop in TFP. We build a dynamic two-sector model of a small open economy with a cash in advance constraint where firms have to finance a part of their purchase of intermediate goods prior to production. The model is calibrated to the Mexican economy before the 1995 crisis and subject to an unexpected shock to interest rates. The financial friction can generate an endogenous fall in TFP of about 3.5 percent and can explain 74 percent of the observed fall in GDP per worker. Adding a cost of adjusting labor between the two sectors and sectoral specificity of capital also generates the sectoral patterns of output and resource use observed in the data after the sudden stop. The results highlight the interaction between interest rates and allocative inefficiencies as an explanation of the real effects of the financial crisis.

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Bibliographic Info

Paper provided by Hunter College Department of Economics in its series Economics Working Paper Archive at Hunter College with number 429.

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Date of creation: 2010
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Handle: RePEc:htr:hcecon:429

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Keywords: Financial frictions; labor market turbulence; adjustment costs; sudden stops; total factor productivity; output fluctuations;

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References

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  1. Elias Brandt & Scott Dressler & Erwan Quintin, 2004. "The real impact of financial crises," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, pages 1-15.
  2. Kehoe, Timothy J. & Ruhl, Kim J., 2009. "Sudden stops, sectoral reallocations, and the real exchange rate," Journal of Development Economics, Elsevier, vol. 89(2), pages 235-249, July.
  3. Neumeyer, Pablo A. & Perri, Fabrizio, 2005. "Business cycles in emerging economies: the role of interest rates," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 345-380, March.
  4. Felipe Meza & Carlos Urrutia, 2010. "Financial Liberalization, Structural Change, and Real Exchange Rate Appreciations," IMF Working Papers 10/63, International Monetary Fund.
  5. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2005. "Sudden Stops and Output Drops," Levine's Bibliography 122247000000000880, UCLA Department of Economics.
  6. Raphael Bergoeing & Patrick J. Kehoe & Timothy J. Kehoe & Raimundo Soto, 2001. "A Decade Lost and Found: Mexico and Chile in the 1980s," NBER Working Papers 8520, National Bureau of Economic Research, Inc.
  7. Ignacio Lobato & Sangeeta Pratap & Alejandro Somuano, 2004. "Debt Composition and Balance Sheet Effects of Exchange Rate Volatility in Mexico: A Firm Level Analysis," Working Papers 0405, Centro de Investigacion Economica, ITAM.
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  9. Uribe, Martin & Yue, Vivian Z., 2006. "Country spreads and emerging countries: Who drives whom?," Journal of International Economics, Elsevier, vol. 69(1), pages 6-36, June.
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  14. Pratap, Sangeeta & Urrutia, Carlos, 2004. "Firm dynamics, investment and debt portfolio: balance sheet effects of the Mexican crisis of 1994," Journal of Development Economics, Elsevier, vol. 75(2), pages 535-563, December.
  15. Felipe Schwartzman, 2010. "Time to produce and emerging market crises," Working Paper 10-15, Federal Reserve Bank of Richmond.
  16. Erwan Quintin & Sangeeta Pratap, 2009. "Financial Crises and Labor Market Turbulence," 2009 Meeting Papers 744, Society for Economic Dynamics.
  17. Valerie A. Ramey & Matthew D. Shapiro, 2001. "Displaced Capital: A Study of Aerospace Plant Closings," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 958-992, October.
  18. Aguiar, Mark, 2005. "Investment, devaluation, and foreign currency exposure: The case of Mexico," Journal of Development Economics, Elsevier, vol. 78(1), pages 95-113, October.
  19. Raphael Bergoeing & Patrick J. Kehoe & Timothy J. Kehoe & Raimundo Soto, 2002. "Data Appendix to A Decade Lost and Found: Mexico and Chile in the 1980s," Technical Appendices bergoeing02, Review of Economic Dynamics.
  20. Meza Felipe & Quintin Erwan, 2007. "Factor Utilization and the Real Impact of Financial Crises," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-41, September.
  21. Alan C. Stockman & Linda L. Tesar, 1990. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," NBER Working Papers 3566, National Bureau of Economic Research, Inc.
  22. Francisco J. Buera & Joseph P. Kaboski & Yongseok Shin, 2011. "Finance and Development: A Tale of Two Sectors," American Economic Review, American Economic Association, vol. 101(5), pages 1964-2002, August.
  23. Felipe Meza & David Benjamin, 2007. "Total Factor Productivity and Labor Reallocation: The Case of the Korean 1997 Crisis," 2007 Meeting Papers 157, Society for Economic Dynamics.
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Citations

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Cited by:
  1. Diego Restuccia & Richard Rogerson, 2012. "Misallocation and Productivity," Working Papers tecipa-468, University of Toronto, Department of Economics.
  2. Felipe Schwartzman, 2010. "Time to produce and emerging market crises," Working Paper 10-15, Federal Reserve Bank of Richmond.
  3. Uras, Burak R., 2014. "Corporate financial structure, misallocation and total factor productivity," Journal of Banking & Finance, Elsevier, vol. 39(C), pages 177-191.
  4. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2009. "On the cyclicality of the interest rate in emerging economy models: solution methods matter," Working Paper 09-13, Federal Reserve Bank of Richmond.
  5. Felipe Meza & Carlos Urrutia, 2008. "Great Appreciations: Accounting for the Real Exchange Rate in Mexico, 1988-2002," Working Papers 0807, Centro de Investigacion Economica, ITAM.
  6. Ezra Oberfield, 2012. "Online Appendix to "Productivity and Misallocation During a Crisis: Evidence from the Chilean Crisis of 1982"," Technical Appendices 11-215, Review of Economic Dynamics.
  7. Queraltó, Albert, 2013. "A Model of Slow Recoveries from Financial Crises," International Finance Discussion Papers 1097, Board of Governors of the Federal Reserve System (U.S.).
  8. Kaoru Hosono & Miho Takizawa, 2012. "Do Financial Frictions Matter as a Source of Misallocation? Evidence from Japan," Discussion papers ron246, Policy Research Institute, Ministry of Finance Japan.

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