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Financial Fragility in Small Open Economies: Firm Balance Sheets and the Sectoral Structure

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  • Yannick Kalantzis

Abstract

Episodes of large capital inflows in small open economies are often associated with a shift of resources from the tradable to the non-tradable sector and sometimes lead to balance-of-payments crises. This article builds a two-sector dynamic model to study the evolution of the sectoral structure and its impact on financial fragility. The model embeds a static mechanism of balance-of-payments crisis which produces multiple equilibria within a single time period when the non-tradable sector is large enough compared to the tradable sector. The article studies the dynamics induced by an increase in financial openness. It shows that the relative size of the non-tradable sector overshoots, which makes the economy more likely to be financially fragile during the transitory dynamics. Using an extended version of the model, the article conducts a quantitative analysis and shows that this mechanism accounts well for several episodes of large capital inflows that led to financial crises.

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  • Yannick Kalantzis, 2015. "Financial Fragility in Small Open Economies: Firm Balance Sheets and the Sectoral Structure," Review of Economic Studies, Oxford University Press, vol. 82(3), pages 1194-1222.
  • Handle: RePEc:oup:restud:v:82:y:2015:i:3:p:1194-1222.
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    File URL: http://hdl.handle.net/10.1093/restud/rdv011
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    Cited by:

    1. Sophie Piton, 2017. "A European Disease? Non-tradable Inflation and Real Interest Rate Divergence," CESifo Economic Studies, CESifo, vol. 63(2), pages 210-234.
    2. Edouard Challe & Jose Ignacio Lopez & Eric Mengus, 2016. "Southern Europe's institutional decline," Working Papers hal-01331723, HAL.
    3. repec:bis:bisbps:95 is not listed on IDEAS
    4. Elstner, Steffen & Feld, Lars P. & Schmidt, Christoph M., 2018. "The German productivity paradox: Facts and explanations," Ruhr Economic Papers 767, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    5. Benigno, Gianluca & Converse, Nathan & Fornaro, Luca, 2015. "Large capital inflows, sectoral allocation, and economic performance," Journal of International Money and Finance, Elsevier, vol. 55(C), pages 60-87.
    6. Cette, Gilbert & Fernald, John & Mojon, Benoît, 2016. "The pre-Great Recession slowdown in productivity," European Economic Review, Elsevier, vol. 88(C), pages 3-20.
    7. repec:eee:jimfin:v:88:y:2018:i:c:p:158-170 is not listed on IDEAS
    8. Sophie Piton, 2018. "Do Unit Labor Costs Matter? A Decomposition Exercise on European Data," PSE Working Papers halshs-01785345, HAL.
    9. Tomas Williams, 2017. "Capital Inflows, Sovereign Debt and Bank Lending: Micro-Evidence from an Emerging Market," Working Papers 2017-12, The George Washington University, Institute for International Economic Policy.
    10. Atif R. Mian & Amir Sufi, 2018. "Finance and Business Cycles: The Credit-Driven Household Demand Channel," NBER Working Papers 24322, National Bureau of Economic Research, Inc.
    11. Mouhamadou Sy, 2016. "Overborrowing and Balance of Payments Imbalances in a Monetary Union," Review of International Economics, Wiley Blackwell, vol. 24(1), pages 67-98, February.
    12. Sophie Piton, 2017. "Economic Integration and the Non-tradable Sector: The European Experience," 2017 Papers ppi361, Job Market Papers.

    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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