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Financial fragility in small open economies: firm balance sheets and the sectoral structure

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  • Y. 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 paper 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 paper 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 paper 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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  • Y. Kalantzis, 2014. "Financial fragility in small open economies: firm balance sheets and the sectoral structure," Working papers 505, Banque de France.
  • Handle: RePEc:bfr:banfra:505
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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. Teimouri, Sheida & Zietz, Joachim, 2018. "The impact of surges in net private capital inflows on manufacturing, investment, and unemployment," Journal of International Money and Finance, Elsevier, vol. 88(C), pages 158-170.
    3. Sophie Piton, 2018. "Do Unit Labor Costs Matter? A Decomposition Exercise on European Data," Working Papers 2018-07, CEPII research center.
    4. Atif Mian & Amir Sufi, 2018. "Finance and Business Cycles: The Credit-Driven Household Demand Channel," Journal of Economic Perspectives, American Economic Association, vol. 32(3), pages 31-58, Summer.
    5. Ignacio Lopez, Jose & Mengus, Eric & Challe, Edouard, 2016. "Southern Europe's Institutional Decline," HEC Research Papers Series 1148, HEC Paris.
    6. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95, 12-2019.
    7. 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.
    8. 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.
    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. Cette, Gilbert & Fernald, John & Mojon, Benoît, 2016. "The pre-Great Recession slowdown in productivity," European Economic Review, Elsevier, vol. 88(C), pages 3-20.
    11. Sophie Piton, 2017. "Economic Integration and the Non-tradable Sector: The European Experience," 2017 Papers ppi361, Job Market Papers.
    12. Chen, Sophia & Ranciere, Romain, 2019. "Financial information and macroeconomic forecasts," International Journal of Forecasting, Elsevier, vol. 35(3), pages 1160-1174.
    13. Niels Gilbert & Sebastiaan Pool, 2020. "Sectoral allocation and macroeconomic imbalances in EMU," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 156(4), pages 945-984, November.
    14. 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.

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    More about this item

    Keywords

    two-sector models; capital account liberalization; balance-of-payments crises; foreign currency debt; borrowing constraint; euro area crisis.;

    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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