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The Role of Expectations in Sudden Stops

  • Mertens, Karel

    (European U Institute, Florence)

This paper presents a flexible-price small open economy model with a "peso problem" in productivity states. Agents rationally adjust their beliefs about future productivity growth after the arrival of news. A downward revision of expectations triggers a Sudden Stop, together with large declines in GDP, employment, consumption and investment. There need not be any actual change in productivity growth to generate large fluctuations. Quantitatively, the model goes a long way in matching the 1998 Korean Crisis and subsequent swift recovery.

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Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number 07-10.

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Date of creation: Jul 2007
Date of revision:
Handle: RePEc:ecl:corcae:07-10
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  1. Danthine, Jean-Pierre & Donaldson, John B & Johnsen, Thore, 1998. "Productivity Growth, Consumer Confidence and the Business Cycle," CEPR Discussion Papers 1779, C.E.P.R. Discussion Papers.
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  9. Danthine, Jean-Pierre & Donaldson, John B, 1999. "Non-falsified Expectations and General Equilibrium Asset Pricing: The Power of the Peso," Economic Journal, Royal Economic Society, vol. 109(458), pages 607-35, October.
  10. Correia, I. & Rabelo, S. & Naves, J.C., 1994. "Business Cycles in a Small Open Economy," RCER Working Papers 382, University of Rochester - Center for Economic Research (RCER).
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  12. Aguiar, Mark & Gopinath, Gita, 2007. "Emerging Market Business Cycles: The Cycle is the Trend," Scholarly Articles 11988098, Harvard University Department of Economics.
  13. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sérgio, 1998. "Prospective Deficits and the Asian Currency Crises," CEPR Discussion Papers 2015, C.E.P.R. Discussion Papers.
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  16. Enrique G. Mendoza & Katherine A. Smith, 2004. "Quantitative Implication of A Debt-Deflation Theory of Sudden Stops and Asset Prices," NBER Working Papers 10940, National Bureau of Economic Research, Inc.
  17. Marianne Baxter & Dorsey Farr, 2001. "Variable Factor Utilization and International Business Cycles," NBER Working Papers 8392, National Bureau of Economic Research, Inc.
  18. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  19. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "What caused the Asian currency and financial crisis?," Japan and the World Economy, Elsevier, vol. 11(3), pages 305-373, October.
  20. Enrique G. Mendoza, 2006. "Endogenous Sudden Stops in a Business Cycle Model with Collateral Constraints:A Fisherian Deflation of Tobin's Q," NBER Working Papers 12564, National Bureau of Economic Research, Inc.
  21. Roberto Chang & Andrés Velasco, 2001. "A Model Of Financial Crises In Emerging Markets," The Quarterly Journal of Economics, MIT Press, vol. 116(2), pages 489-517, May.
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  24. Susanto Basu & Miles S. Kimball, 1997. "Cyclical Productivity with Unobserved Input Variation," NBER Working Papers 5915, National Bureau of Economic Research, Inc.
  25. Lane, Philip & Milesi-Ferretti, Gian Maria, . "External Wealth of Nations," Instructional Stata datasets for econometrics extwealth, Boston College Department of Economics.
  26. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  27. Maurice Obstfeld, 1984. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc.
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