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A Dual Liquidity Model for Emerging Markets

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  • Ricardo J. Caballero
  • Arvind Krishnamurthy

Abstract

The last few years have seen a significant re-evaluation of the models used to analyze crises in emerging markets. Recent models typically stress financial constraints or distorted financial incentives. While this certainly represents progress, these models share a weakness with the earlier work: neither is uniquely about emerging markets. Adaptations of the Mundell-Fleming model represent Argentina as a Belgium with larger external shocks. Likewise, emerging market models of financial constraints are adaptations of developed economy ones with tighter financial constraints. In our work, we have advocated a model which distinguishes between the financial constraints affecting borrowing and lending among agents within an emerging economy, and those affecting borrowing from foreign lenders. This 'dual liquidity' model offers a parsimonious description of the behavior of firms, governments, and asset prices during financial crises. It also provides prescriptions for optimal policy responses to these crises.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8758.

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Date of creation: Jan 2002
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Handle: RePEc:nbr:nberwo:8758

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  1. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
  2. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
  3. Ben S. Bernanke & Alan S. Blinder, 1989. "Credit, Money, and Aggregate Demand," NBER Working Papers 2534, National Bureau of Economic Research, Inc.
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