From Sudden Stops to Fisherian Deflation: Quantitative Theory and Policy Implications
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.
We would like to acknowledge An Wang for his superb research assistance. Korinek thanks Olivier Jeanne for his coauthorship and inspiration on a number of projects on which we draw in this survey. He also acknowledges financial support from CIGI/INET and the IMF. The views expressed are those of the author and should not be attributed to the IMF. Mendoza would like to thank Javier Bianchi, Emine Boz, Bora Durdu, Katherine Smith, Marco Terrones, and specially Guillermo Calvo for the opportunity to collaborate with them on several papers on the Sudden Stops phenomenon that served as background material for this article. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Data for our event analysis of sudden stops, Matlab source codes and supplementary materials are available at http://www.korinek.com/suddenstops
From Sudden Stops to Fisherian Deflation: Quantitative Theory and Policy Annual Review of Economics Vol. 6: 299-332