Balance Sheet Effects, Bailout Guarantees and Financial Crises

Martin Schneider and Aaron Tornell

The Review of Economic Studies, 2004, vol. 71, issue 3, 883-913

Abstract: 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. Copyright 2004, Wiley-Blackwell.

Date: 2004
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Working Paper: Balance SHeet Effects, Bailout Guarantees and Financial Crises (2000)
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