Sudden Stops, Financial Crises, and Leverage

Mendoza, Enrique G.

doi:10.1257/aer.100.5.1941

Cited by 831 publications

(636 citation statements)

References 26 publications

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“…At equilibrium, this vicious circle results in a complete collapse of trades. Therefore, similarly to Cao (2010) and Lin et al (2010), we show that the debt-deflation channel still operates in a closedeconomy with endogenous interest rates, as opposed to exogenous interest rates in a small open economy as in Mendoza (2010). Moreover, while in Cao (2010), debtdeflation occurs when a bad shock hits the economy, here, in a position more similar to Lin et al (2010), it results from the monetary policy itself.…”

Section: The Monetary Dilemmasupporting

confidence: 69%

“…Our approach is related to the work on the debt deflation theory of Sudden Stops (Mendoza, 2006(Mendoza, , 2010Mendoza and Smith, 2006). They introduce collateral constraints in an RBC model of a Small Open Economy to show that when debt is sufficiently high, an adverse productivity shock triggers the constraints and results in a fire-sale spiral, falling prices and a reduction in output.…”

Section: Related Literaturementioning

confidence: 99%

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Debt-deflation versus the liquidity trap: the dilemma of nonconventional monetary policy

Giraud

Pottier

2015

Econ Theory

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This paper examines quantity-targeting monetary policy in a two-period economy with fiat money, endogenously incomplete markets of financial securities, durable goods and production. Short positions in financial assets and long-term loans are backed by collateral, the value of which depends on monetary policy. The decision to default is endogenous and depends on the relative value of the collateral to the loan. We show that Collateral Monetary Equilibria exist and prove a refinement of the Quantity Theory of Money that turns out to be compatible with the long-run non-neutrality of money. Moreover, only three scenarios are compatible with the equilibrium condition: 1) either the economy enters a liquidity trap in the first period; 2) or a credible expansionary monetary policy accompanies the orderly functioning of markets at the cost of running an inflationary risk; 3) else the money injected by the Central Bank increases the leverage of indebted investors, fueling a financial bubble whose bursting leads to debt-deflation in the next period with a non-zero probability. This dilemma of monetary policy highlights the default channel affecting trades and production, and provides a rigorous foundation to Fisher's debt deflation theory as being distinct from Keynes' liquidity trap.

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Section: The Monetary Dilemmasupporting

confidence: 69%

Section: Related Literaturementioning

confidence: 99%

Debt-deflation versus the liquidity trap: the dilemma of nonconventional monetary policy

Giraud

Pottier

2015

Econ Theory

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“…In addition, it would be interesting to consider collateral constraints in which asset prices, for instance house prices, play a role in determining access to credit. Mendoza (2010) Also the numerical solution to the model with multi-period wage rigidities is derived using the method described above. However, the presence of another endogenous state variable, the period 0 nominal wage, for the periods in which wages are partly rigid increases significantly the time needed to obtain a numerical solution.…”

Section: Resultsmentioning

confidence: 99%

International Debt Deleveraging

Fornaro

2018

Journal of the European Economic Association

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I provide a framework for understanding debt deleveraging in a group of financially integrated countries. During an episode of international deleveraging world consumption demand is depressed and the world interest rate is low, reflecting a high propensity to save. If exchange rates are allowed to float, deleveraging countries can depreciate their nominal exchange rate to increase production and mitigate the fall in consumption associated with debt reduction. The key insight of the paper is that in a monetary union this channel of adjustment is shut off, and therefore the falls in consumption demand and in the world interest rate are amplified. Hence, monetary unions are especially prone to hit the zero lower bound on the nominal interest rate and enter a liquidity trap during deleveraging. In a liquidity trap deleveraging gives rise to a union-wide recession, which is particularly severe in high-debt countries. The model suggests several policy interventions that mitigate the negative impact of deleveraging on output in monetary unions.JEL Classification Numbers: E31, E44, E52, F32, F34, F41, G01, G15.

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“…4 Mendoza (2010) is one prominent recent example. M A N U S C R I P T ACCEPTED MANUSCRIPT 5 imbalances.…”

Section: Accepted Manuscriptmentioning

confidence: 99%

External adjustment and the global crisis

Lane

Milesi‐Ferretti

2012

Journal of International Economics

239

163

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The period preceding the global financial crisis was characterized by a substantial widening of current account imbalances across the world. Since the onset of the crisis, these imbalances have contracted to a significant extent. In this paper, we analyze the ongoing process of external adjustment in advanced economies and emerging markets. We find that countries whose precrisis current account balances were in excess of what could be explained by standard economic fundamentals have experienced the largest contractions in their external balance. We subsequently examine the contributions of real exchange rates, domestic demand and domestic output to the adjustment process (allowing for differences across exchange rate regimes) and find that external adjustment in deficit countries was achieved primarily through demand compression, rather than expenditure switching. Finally, we show that changes in other investment flows were the main channel of financial account adjustment, with official external assistance and ECB liquidity cushioning the exit of private capital flows for some countries.

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Sudden Stops, Financial Crises, and Leverage

Cited by 831 publications

References 26 publications

Debt-deflation versus the liquidity trap: the dilemma of nonconventional monetary policy

Debt-deflation versus the liquidity trap: the dilemma of nonconventional monetary policy

International Debt Deleveraging

External adjustment and the global crisis

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