Banks and Macroeconomics Disturbances under Predetermined Exchange Rates

Sebastian Edwards, Carlos A. Vegh

NBER Working Paper No. 5977
Issued in March 1997
NBER Program(s):   IFM

As the recent Mexican crisis vividly illustrates, Latin American countries often go through boom-bust cycles caused by both domestic policies and external shocks. Such cycles are typically magnified by weak banking systems which intermediate large capital inflows. This paper develops a simple optimizing model to analyze how the banking sector affects the propagation of shocks. In particular, we show how the world business cycle and shocks to the banking system affect output and employment through fluctuations in bank credit. We also analyze the countercyclical use of reserve requirements. Econometric evidence for Chile and Mexico supports the main predictions of the model.

(1991 K)

Published: Journal of Monetary Economics, Vol.40 (November 1997): 239-278.

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