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Financial Frictions and Total Factor Productivity: Accounting for the Real Effects of Financial Crises

The financial crises or “sudden stops” of the last decade in emerging economies were accompanied by a large fall in total factor productivity. In this paper we explore the role of financial frictions in exacerbating the misallocation of resources and explaining this drop in TFP. We build a dynamic two-sector model of a small open economy with a cash in advance constraint where firms have to finance a part of their purchase of intermediate goods prior to production. The model is calibrated to the Mexican economy before the 1995 crisis and subject to an unexpected shock to interest rates. The financial friction can generate an endogenous fall in TFP of about 3.5 percent and can explain 74 percent of the observed fall in GDP per worker. Adding a cost of adjusting labor between the two sectors and sectoral specificity of capital also generates the sectoral patterns of output and resource use observed in the data after the sudden stop. The results highlight the interaction between interest rates and allocative inefficiencies as an explanation of the real effects of the financial crisis.

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Paper provided by Hunter College Department of Economics in its series Economics Working Paper Archive at Hunter College with number 429.

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Date of creation: 2010
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Handle: RePEc:htr:hcecon:429
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  1. Aguiar, Mark, 2005. "Investment, devaluation, and foreign currency exposure: The case of Mexico," Journal of Development Economics, Elsevier, vol. 78(1), pages 95-113, October.
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  4. Erwan Quintin & Sangeeta Pratap, 2009. "Financial Crises and Labor Market Turbulence," 2009 Meeting Papers 744, Society for Economic Dynamics.
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  7. Felipe Schwartzman, 2010. "Time to produce and emerging market crises," Working Paper 10-15, Federal Reserve Bank of Richmond.
  8. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2005. "Sudden Stops and Output Drops," Levine's Bibliography 122247000000000880, UCLA Department of Economics.
  9. Ignacio Lobato & Sangeeta Pratap & Alejandro Somuano, 2004. "Debt Composition and Balance Sheet Effects of Exchange Rate Volatility in Mexico: A Firm Level Analysis," Working Papers 0405, Centro de Investigacion Economica, ITAM.
  10. Guillermo A. Calvo & Alejandro Izquierdo & Ernesto Talvi, 2006. "Phoenix Miracles in Emerging Markets: Recovering without Credit from Systemic Financial Crises," Research Department Publications 4474, Inter-American Development Bank, Research Department.
  11. Raphael Bergoeing & Patrick J. Kehoe & Timothy J. Kehoe & Raimundo Soto, 2002. "Decades lost and found: Mexico and Chile since 1980," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-30.
  12. Benjamin David & Meza Felipe, 2009. "Total Factor Productivity and Labor Reallocation: The Case of the Korean 1997 Crisis," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-41, July.
  13. Meza Felipe & Quintin Erwan, 2007. "Factor Utilization and the Real Impact of Financial Crises," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-41, September.
  14. Raphael Bergoeing & Patrick J. Kehoe & Timothy J. Kehoe & Raimundo Soto, 2002. "A Decade Lost and Found: Mexico and Chile in the 1980s," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(1), pages 166-205, January.
  15. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-85, March.
  16. Enrique G. Mendoza, 2010. "Sudden Stops, Financial Crises, and Leverage," American Economic Review, American Economic Association, vol. 100(5), pages 1941-66, December.
  17. Diego Restuccia & Richard Rogerson, 2007. "Policy Distortions and Aggregate Productivity with Heterogeneous Plants," Working Papers tecipa-283, University of Toronto, Department of Economics.
  18. Felipe Meza & Carlos Urrutia, 2010. "Financial Liberalization, Structural Change, and Real Exchange Rate Appreciations," IMF Working Papers 10/63, International Monetary Fund.
  19. Elias Brandt & Scott Dressler & Erwan Quintin, 2004. "The real impact of financial crises," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, pages 1-15.
  20. Martin Uribe & Vivian Yue, 2004. "Country spreads and emerging countries: who drives whom?," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  21. Pratap, Sangeeta & Urrutia, Carlos, 2004. "Firm dynamics, investment and debt portfolio: balance sheet effects of the Mexican crisis of 1994," Journal of Development Economics, Elsevier, vol. 75(2), pages 535-563, December.
  22. Ruy Lama & Carlos Urrutia, 2011. "Employment Protection and Business Cycles in Emerging Economies," IMF Working Papers 11/293, International Monetary Fund.
  23. Valerie A. Ramey & Matthew D. Shapiro, 2001. "Displaced Capital: A Study of Aerospace Plant Closings," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 958-992, October.
  24. Meza, Felipe & Urrutia, Carlos, 2011. "Financial liberalization, structural change, and real exchange rate appreciations," Journal of International Economics, Elsevier, vol. 85(2), pages 317-328.
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