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Financial Fragility and Currency Crisis: a Macrodynamical Revisitation of the Argentina’s Experience

Bernardo Maggi, Eleonora Cavallaro () and Marcella Mulino ()

No 8, Working Papers - Dipartimento di Economia from Dipartimento di Economia, Sapienza University of Rome

Abstract: The paper presents an open-economy macrodynamical growth model with the aim of giving an endogenous characterisation to the process that leads a small country with a currency-board arrangement to accumulate dangerously high levels of external debt and become vulnerable to macroeconomic instability. The macrodynamics of the model results from the combination of the commitment to maintain the peg - that makes liquidity closely dependent on the dynamics of foreign reserves – and the non-linear real and financial interactions that drives the pro-cyclical behaviour of the economy. Within this context, the external finance ease during an economic upswing leads to debt-supported growth and financial fragility; the consequent deterioration of profitability expectations brings about a capital reversal that, in the absence of monetary stabilization tools, makes the currency arrangement unsustainable. A financial crisis may thus turn into a currency crisis. We run a continuous-time estimation of a non-linear differential equations system for Argentina during the years of the currency-board arrangement. We find that two steady-state solutions exist. The local stability and sensitivity analysis show that both equilibria are unstable and that the qualitative nature of the equilibria depends in particular on lenders’ responsiveness to the degree of leverage. On the contrary, when considering a different currency arrangement with an autonomous monetary policy, the system becomes stable.

Keywords: Currency Board; Financial Crisis; Monetary policy; Continuous Time Econometrics; Stability; Sensitivity (search for similar items in EconPapers)
JEL-codes: G01 C51 C62 F34 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mon
Date: 2010, Revised 2010
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