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A Fisherian Approach to Financial Crises:Lessons from the Sudden Stops Literature

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  • Javier Bianchi

    (Federal Reserve Bank of Minneapolis)

  • Enrique G. Mendoza

    (University of Pennsylvania, NBER & PIER)

Abstract

Sudden Stops are ?nancial crises de?ned by a large, sudden current-account reversal. They occur in both advanced and emerging economies and result in deep recessions, collapsing asset prices, and real exchange-rate depreciations. They are preceded by economic expan-sions, current-account de?cits, credit booms, and appreciated asset prices and real exchange rates. Fisherian models (i.e. models with credit constraints linked to market prices) ex-plain these stylized facts as an outcome of Irving Fisher’s debt-de?ation mechanism. On the normative side, these models feature a pecuniary externality that provides a foundation for macroprudential policy (MPP). We review the stylized facts of Sudden Stops, the evi-dence on MPP use and e?ectiveness, and the ?ndings of the literature on Fisherian models. Quantitatively, Fisherian ampli?cation is strong and optimal MPP reduces sharply the size and frequency of crises, but it is also complex and potentially time-inconsistent, and simple MPP rules are less e?ective. We also provide a new MPP analysis incorporating investment. Using a constant debt-tax policy, we construct a crisis probability-output frontier showing that there is a tradeo? between ?nancial stability and long-run output (i.e., reducing the probability of crises reduces long-run output).

Suggested Citation

  • Javier Bianchi & Enrique G. Mendoza, 2020. "A Fisherian Approach to Financial Crises:Lessons from the Sudden Stops Literature," PIER Working Paper Archive 20-027, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  • Handle: RePEc:pen:papers:20-027
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    10. Davis, J. Scott & Devereux, Michael B. & Yu, Changhua, 2023. "Sudden stops and optimal foreign exchange intervention," Journal of International Economics, Elsevier, vol. 141(C).
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    14. J. Scott Davis & Michael B. Devereux & Changhua Yu, 2020. "Sudden Stops in Emerging Economies: The Role of World Interest Rates and Foreign Exchange Intervention," Globalization Institute Working Papers 405, Federal Reserve Bank of Dallas, revised 10 Sep 2021.
    15. Bengui, Julien & Bianchi, Javier, 2022. "Macroprudential policy with leakages," Journal of International Economics, Elsevier, vol. 139(C).
    16. Javier Bianchi, 2022. "The Research Agenda: Javier Bianchi on Financial Crises and Prudential Policies," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 23(1), April.
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    More about this item

    Keywords

    Stochastic Sudden Stops; Financial crises; Macroprudential policy;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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