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Balance SHeet Effects, Bailout Guarantees and Financial Crises

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  • Martin Schneider
  • Aaron Tornell

Abstract

Several recent twin' currency and banking crises were preceded by lending booms during which the banking system financed rapid growth of the nontradable (N) sector by borrowing in foreign currency. They were followed by recessions during which a sharp decline in credit especially hurt the N-sector. This paper presents a model that accounts for these stylized facts. A crucial element is that we model a banking system that is simultaneously subject to two distortions typical of international credit markets: bailout guarantees and the imperfect enforceability of contracts. The interaction of these distortions produces unusually fast N-sector growth, together with a real appreciation, during the boom. However, it is also responsible for self-fulfilling twin crises, which have persistent adverse effects on N-sector output.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8060.

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Date of creation: Dec 2000
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Handle: RePEc:nbr:nberwo:8060

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  1. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," Working Paper 98-10, Federal Reserve Bank of Atlanta.
  2. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
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  5. Kenneth Kasa, 1998. "Borrowing constraints and asset market dynamics: evidence from the Pacific Basin," Economic Review, Federal Reserve Bank of San Francisco, pages 17-28.
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  8. Ronald I. McKinnon & Huw Pill, 1998. "International Overborrowing: A Decomposition of Credit and Currency Risks," Working Papers 98004, Stanford University, Department of Economics.
  9. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
  10. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  11. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
  12. Aaron Tornell, 1999. "Common Fundamentals in the Tequila and Asian Crises," Harvard Institute of Economic Research Working Papers 1868, Harvard - Institute of Economic Research.
  13. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March.
  14. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-58, December.
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