Balance Sheet Effects, Bailout Guarantees and Financial Crises

This paper provides a model of boom-bust episodes in middle-income countries. It is based on sectoral differences in corporate finance: the nontradables sector is special in that it faces a contract enforceability problem and enjoys bailout guarantees. As a result, currency mismatch and borrowing co...

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Bibliographic Details
Published in:The Review of economic studies 2004-07, Vol.71 (3), p.883-913
Main Authors: Schneider, Martin, Tornell, Aaron
Format: Article
Language:English
Subjects:
Balance sheets
Bankruptcy
Credit
Debt
E32
Economic crises
Economic history
F31
F41
Financial crisis
Financial investments
G30
Investment credit
Investment strategies
Lenders
Loans
Productivity
Real exchange rates
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Summary:This paper provides a model of boom-bust episodes in middle-income countries. It is based on sectoral differences in corporate finance: the nontradables sector is special in that it faces a contract enforceability problem and enjoys bailout guarantees. As a result, currency mismatch and borrowing constraints arise endogenously in that sector. This sectoral asymmetry allows the model to replicate the main features of observed boom-bust episodes. In particular, episodes begin with a lending boom and a real appreciation, peak in a self-fulfilling crisis during which a real depreciation coincides with widespread bankruptcies, and end in a recession and credit crunch. The nontradables sector accounts for most of the volatility in output and credit.
ISSN:0034-6527
1467-937X
DOI:10.1111/j.1467-937X.2004.00308.x