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Financial Fragility and Currency Crisis: a Macrodynamical Revisitation of the Argentina’s Experience

Author

Listed:
  • Bernardo Maggi
  • Eleonora Cavallaro
  • Marcella Mulino

    () (Univ. of Rome “La Sapienza”)

Abstract

The paper presents an open-economy macrodynamical growth model with the aim of giving an endogenous characterisation to the process that leads a small country with a currency-board arrangement to accumulate dangerously high levels of external debt and become vulnerable to macroeconomic instability. The macrodynamics of the model results from the combination of the commitment to maintain the peg - that makes liquidity closely dependent on the dynamics of foreign reserves – and the non-linear real and financial interactions that drives the pro-cyclical behaviour of the economy. Within this context, the external finance ease during an economic upswing leads to debt-supported growth and financial fragility; the consequent deterioration of profitability expectations brings about a capital reversal that, in the absence of monetary stabilization tools, makes the currency arrangement unsustainable. A financial crisis may thus turn into a currency crisis. We run a continuous-time estimation of a non-linear differential equations system for Argentina during the years of the currency-board arrangement. We find that two steady-state solutions exist. The local stability and sensitivity analysis show that both equilibria are unstable and that the qualitative nature of the equilibria depends in particular on lenders’ responsiveness to the degree of leverage. On the contrary, when considering a different currency arrangement with an autonomous monetary policy, the system becomes stable.

Suggested Citation

  • Bernardo Maggi & Eleonora Cavallaro & Marcella Mulino, 2010. "Financial Fragility and Currency Crisis: a Macrodynamical Revisitation of the Argentina’s Experience," Working Papers - Dipartimento di Economia 8, Dipartimento di Economia, Sapienza University of Rome, revised 2010.
  • Handle: RePEc:des:wpaper:18
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    File URL: http://dipartimento.dse.uniroma1.it/Economia/publications/papers/maggi8.pdf
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    References listed on IDEAS

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    1. Maggi, Bernardo & Padoan, Pier Carlo & Guerrieri, Paolo, 2009. "A continuous time model of European growth, integration and technology diffusion: The role of distance," Economic Modelling, Elsevier, vol. 26(3), pages 631-640, May.
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    Cited by:

    1. Cavallaro, Eleonora & Maggi, Bernardo & Mulino, Marcella, 2011. "The macrodynamics of financial fragility within a hard peg arrangement," Economic Modelling, Elsevier, vol. 28(5), pages 2164-2173, September.
    2. Maggi Bernardo & Cavallaro Eleonora & Mulino Marcella, 2012. "The Macrodynamics of External Overborrowing and Systemic Instability in a Small Open Economy," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 16(2), pages 1-27, April.

    More about this item

    Keywords

    Currency Board; Financial Crisis; Monetary policy; Continuous Time Econometrics; Stability; Sensitivity;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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