Working Paper: NBER ID: w14444
Authors: Enrique G. Mendoza
Abstract: This paper shows that the quantitative predictions of a DSGE model with an endogenous collateral constraint are consistent with key features of the emerging markets' Sudden Stops. Business cycle dynamics produce periods of expansion during which the ratio of debt to asset values raises enough to trigger the constraint. This sets in motion a deflation of Tobin's Q driven by Irving Fisher's debt-deflation mechanism, which causes a spiraling decline in credit access and in the price and quantity of collateral assets. Output and factor allocations decline because the collateral constraint limits access to working capital financing. This credit constraint induces significant amplification and asymmetry in the responses of macro-aggregates to shocks. Because of precautionary saving, Sudden Stops are low probability events nested within normal cycles in the long run.
Keywords: sudden stops; financial crises; leverage; Tobin's Q; debt-deflation mechanism
JEL Codes: D52; E32; E44; F32; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| endogenous collateral constraint (D10) | responses of macroeconomic aggregates (E00) |
| binding collateral constraint (G33) | decline in Tobin's Q (D25) |
| decline in Tobin's Q (D25) | reduced credit access (G21) |
| reduced credit access (G21) | spiral of asset price declines (E32) |
| binding collateral constraint (G33) | declines in output, investment, and consumption (E20) |
| high leverage states (H74) | sudden stops (F32) |
| sudden stops (F32) | declines in production and factor allocations (E23) |
| sudden stops (F32) | average response of GDP during sudden stops (E20) |
| sudden stops (F32) | investment collapses (E22) |