Journal Article

Balance Sheet Effects, Bailout Guarantees and Financial Crises

Martin Schneider and Aaron Tornell

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 71, issue 3, pages 883-913
Published in print July 2004 | ISSN: 0034-6527
Published online July 2004 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2004.00308.x
Balance Sheet Effects, Bailout Guarantees and Financial Crises

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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.

Keywords: E32; F31; F41; G30

Journal Article.  16474 words.  Illustrated.

Subjects: Corporate Governance ; Prices, Business Fluctuations, and Cycles ; Macroeconomic Aspects of International Trade and Finance ; International Finance

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