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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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Paper provided by Hunter College: Department of Economics in its series Hunter College Department of Economics Working Papers 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. Francisco J. Buera & Joseph Kaboski & Yongseok Shin, 2009. "Finance and Development: A Tale of Two Sectors," NBER Working Papers 14914, National Bureau of Economic Research, Inc.
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  8. Sangeeta Pratap & Erwan Quintin, 2010. "Financial Crises and Labor Market Turbulence," Hunter College Department of Economics Working Papers 428, Hunter College: Department of Economics.
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  17. Felipe Schwartzman, 2010. "Time to produce and emerging market crises," Working Paper 10-15, Federal Reserve Bank of Richmond.
  18. 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.
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  20. 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.
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Citations

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Cited by:
  1. 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.
  2. Diego Restuccia & Richard Rogerson, 2012. "Misallocation and Productivity," Working Papers tecipa-468, University of Toronto, Department of Economics.
  3. 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.
  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 Schwartzman, 2010. "Time to produce and emerging market crises," Working Paper 10-15, Federal Reserve Bank of Richmond.
  6. 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.
  7. Uras, Burak R., 2014. "Corporate financial structure, misallocation and total factor productivity," Journal of Banking & Finance, Elsevier, vol. 39(C), pages 177-191.

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