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The Role of Expectations in Sudden Stops

Karel Mertens

Working Papers from Cornell University, Center for Analytic Economics

Abstract: This paper presents a flexible-price small open economy model with a "peso problem" in productivity states. Agents rationally adjust their beliefs about future productivity growth after the arrival of news. A downward revision of expectations triggers a Sudden Stop, together with large declines in GDP, employment, consumption and investment. There need not be any actual change in productivity growth to generate large fluctuations. Quantitatively, the model goes a long way in matching the 1998 Korean Crisis and subsequent swift recovery.

JEL-codes: E20 E30 F30 F40 (search for similar items in EconPapers)
Date: 2007-07
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:corcae:07-10

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