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From Sudden Stops to Fisherian Deflation: Quantitative Theory and Policy Implications

  • Anton Korinek
  • Enrique G. Mendoza

The 1990s Sudden Stops in emerging markets were a harbinger for the 2008 global financial crisis. During Sudden Stops, countries lost access to credit, causing abrupt current account reversals, and suffered Great Recessions. This paper reviews a class of models that yields quantitative predictions consistent with these observations, based on an occasionally binding credit constraint that limits debt to a fraction of the market value of incomes or assets used as collateral. Sudden Stops are infrequent events nested within regular business cycles, and occur in response to standard shocks after periods of expansion increase leverage ratios sufficiently. When this happens, the Fisherian debt-deflation mechanism is set in motion, as lower asset or goods prices tighten further the constraint causing further deflation. This framework also embodies a pecuniary externality with important implications for macro-prudential policy, because agents do not internalize how current borrowing decisions affect collateral values during future financial crises.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19362.

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Date of creation: Aug 2013
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Handle: RePEc:nbr:nberwo:19362
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