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The Credit Channel in Middle Income Countries

  • Aaron Tornell
  • Frank Westermann

Credit market conditions play a key role in propagating shocks in middle income countries (MICs). In particular, shocks to the spread between domestic and international interest rates have a strong effect on GDP, and an even stronger effect on domestic credit. This strong credit channel is associated with a sharp sectorial asymmetry: the output of the bank-dependent nontradables (N) sector reacts more strongly than tradables (T) output. This asymmetry, in turn, is associated with a strong reaction of the real exchange rate --the relative price between N and T goods. We present a model that reconciles these facts and leads to a well specified estimation framework. From the equilibrium we derive structural VARs that allow us to identify shocks to credit market conditions and trace their effects on the economy. We estimate these structural VARs for a group of MICs and find evidence of a strong credit channel. We argue that at the heart of the MIC credit channel are a deep asymmetry in financing opportunities across N and T sectors, and a severe currency mismatch. This makes movements in the real exchange rate the driving element in the amplification of shocks. Finally, we show that the model's key assumptions are consistent with evidence gleaned from both firm level and aggregate data.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9355.

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Date of creation: Dec 2002
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Publication status: published as Tornell, Aaron and Frank Westermann. "Boom-Bust Cycles In Middle Income Countries," International Monetary Fund Staff Papers, 2002, v49(Spec), 111-155.
Handle: RePEc:nbr:nberwo:9355
Note: IFM ME
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  1. Gertler, M. & Gilchrist, S., 1993. "Monetary Policy, Business Cycles and the Behavior of Small Manufacturing Firms," Working Papers 93-02, C.V. Starr Center for Applied Economics, New York University.
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  18. McKinnon, Ronald I & Pill, Huw, 1997. "Credible Economic Liberalizations and Overborrowing," American Economic Review, American Economic Association, vol. 87(2), pages 189-93, May.
  19. Jeremy C. Stein & Anil K. Kashyap, 2000. "What Do a Million Observations on Banks Say about the Transmission of Monetary Policy?," American Economic Review, American Economic Association, vol. 90(3), pages 407-428, June.
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