External debt in emerging economies: a macrodynamical model of financial fragility
AbstractFollowing both the balance-sheet approach to currency crises and the financial fragility literature, the paper presents an open economy macrodynamical monetary growth model with the aim of giving an endogenous characterisation to the process that, over time, leads an emerging economy to accumulate dangerously high levels of debt and to be vulnerable to macroeconomic instability. The model explores the nonlinear real and financial interaction at work, with the endogenously generated liquidity feeding back dynamically to firmsâ€™ investment, the level of output, the interest rate and the expected rate of return. The paper shows that the system may display instability if lenders and borrowers are not too concerned with firmsâ€™ degree of leverage, profitability expectations do not take adequately into account firmsâ€™ financial structure, and destabilising feedback mechanisms dominate, which go from debt accumulation and profitability expectations onto the rate of profit and the interest rate. As a result, the economy may incur in excessive foreign borrowing. The consequent worsening in firmsâ€™ balance sheets may turn into financial fragility, and over time bring about a fall in external lending. A prolonged recession may thus follow, possibly calling into question the currency arrangements; hence, a financial crisis may turn into a currency crisis.
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Bibliographic InfoPaper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 68.
Date of creation: Feb 2002
Date of revision:
Foreign currency debt; Balance sheet approach; Financial Fragility; Macrodynamics.;
Other versions of this item:
- Eleonora Cavallaro & Marcella Mulino, 2004. "External Debt in Emerging Economies: A Macrodynamical Model of Financial Fragility," STUDI ECONOMICI, FrancoAngeli Editore, vol. 2004(84).
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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- Mulino, Marcella, 2002. "Currency boards, credibility and crises," Economic Systems, Elsevier, vol. 26(4), pages 381-386, December.
- Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000.
"Balance Sheets and Exchange Rate Policy,"
NBER Working Papers
7840, National Bureau of Economic Research, Inc.
- Barry Eichengreen & Ricardo Hausmann & Ugo Panizza, 2007. "Currency Mismatches, Debt Intolerance, and the Original Sin: Why They Are Not the Same and Why It Matters," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 121-170 National Bureau of Economic Research, Inc.
- Gatti, D. Delli & Gallegati, M. & Gardini, L., 1993. "Investment confidence, corporate debt and income fluctuations," Journal of Economic Behavior & Organization, Elsevier, vol. 22(2), pages 161-187, October.
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