The Credit Channel in Middle Income Countries

Aaron Tornell and Frank Westermann

No 9355, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Credit market conditions play a key role in propagating shocks in middle income countries (MICs). In particular, shocks to the spread between domestic and international interest rates have a strong effect on GDP, and an even stronger effect on domestic credit. This strong credit channel is associated with a sharp sectorial asymmetry: the output of the bank-dependent nontradables (N) sector reacts more strongly than tradables (T) output. This asymmetry, in turn, is associated with a strong reaction of the real exchange rate --the relative price between N and T goods. We present a model that reconciles these facts and leads to a well specified estimation framework. From the equilibrium we derive structural VARs that allow us to identify shocks to credit market conditions and trace their effects on the economy. We estimate these structural VARs for a group of MICs and find evidence of a strong credit channel. We argue that at the heart of the MIC credit channel are a deep asymmetry in financing opportunities across N and T sectors, and a severe currency mismatch. This makes movements in the real exchange rate the driving element in the amplification of shocks. Finally, we show that the model's key assumptions are consistent with evidence gleaned from both firm level and aggregate data.

JEL-codes: E32 F32 (search for similar items in EconPapers)
Date: 2002-12
New Economics Papers: this item is included in nep-ifn and nep-mon
Note: IFM ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (30)

Published as Tornell, Aaron and Frank Westermann. "Boom-Bust Cycles In Middle Income Countries," International Monetary Fund Staff Papers, 2002, v49(Spec), 111-155.

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