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American Economic Review: Vol. 100 No. 5 (December 2010)

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Sudden Stops, Financial Crises, and Leverage

Article Citation

Mendoza, Enrique G. 2010. "Sudden Stops, Financial Crises, and Leverage." American Economic Review, 100(5): 1941-66.

DOI: 10.1257/aer.100.5.1941

Abstract

Financial crashes were followed by deep recessions in the Sudden Stops of emerging economies. An equilibrium business cycle model with a collateral constraint explains this phenomenon as a result of the amplification and asymmetry that the constraint induces in the responses of macro-aggregates to shocks. Leverage rises during expansions, and when it rises enough it triggers the constraint, causing a Fisherian deflation that reduces credit and the price and quantity of collateral assets. Output and factor allocations fall because access to working capital financing is also reduced. Precautionary saving makes Sudden Stops low probability events nested within normal cycles, as observed in the data. (JEL E21, E23, E32, E44, G01, O11, O16)

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Authors

Mendoza, Enrique G. (U MD)

JEL Classifications

E21: Macroeconomics: Consumption; Saving; Wealth
E23: Macroeconomics: Production
E32: Business Fluctuations; Cycles
E44: Financial Markets and the Macroeconomy
G01: Financial Crises
O11: Macroeconomic Analyses of Economic Development
O16: Economic Development: Financial Markets; Saving and Capital Investment; Corporate Finance and Governance


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