Working Paper: NBER ID: w19362
Authors: Anton Korinek; Enrique G. Mendoza
Abstract: 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.
Keywords: Sudden Stops; Fisherian Deflation; Quantitative Theory; Macroeconomic Policy
JEL Codes: E44; F34; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sudden stops (F32) | sharp reversal in external capital inflows (F32) |
| sharp reversal in external capital inflows (F32) | deep recessions (E32) |
| deep recessions (E32) | Fisherian debt-deflation mechanism (E31) |
| Fisherian debt-deflation mechanism (E31) | lower asset prices (G19) |
| lower asset prices (G19) | tighter collateral constraints (E51) |
| tighter collateral constraints (E51) | further deflation (E31) |
| financial amplification mechanism (E44) | severity of economic downturns (F44) |
| leverage ratios (G32) | tightening of collateral constraints (F65) |
| macroprudential policies (E60) | mitigate adverse effects of financial amplification mechanisms (E44) |