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A Fisherian Approach to Financial Crises:Lessons from the Sudden Stops Literature

Javier Bianchi () and Enrique Mendoza ()

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: Sudden Stops are ?nancial crises de?ned by a large, sudden current-account reversal. They occur in both advanced and emerging economies and result in deep recessions, collapsing asset prices, and real exchange-rate depreciations. They are preceded by economic expan-sions, current-account de?cits, credit booms, and appreciated asset prices and real exchange rates. Fisherian models (i.e. models with credit constraints linked to market prices) ex-plain these stylized facts as an outcome of Irving Fisher’s debt-de?ation mechanism. On the normative side, these models feature a pecuniary externality that provides a foundation for macroprudential policy (MPP). We review the stylized facts of Sudden Stops, the evi-dence on MPP use and e?ectiveness, and the ?ndings of the literature on Fisherian models. Quantitatively, Fisherian ampli?cation is strong and optimal MPP reduces sharply the size and frequency of crises, but it is also complex and potentially time-inconsistent, and simple MPP rules are less e?ective. We also provide a new MPP analysis incorporating investment. Using a constant debt-tax policy, we construct a crisis probability-output frontier showing that there is a tradeo? between ?nancial stability and long-run output (i.e., reducing the probability of crises reduces long-run output).

Keywords: Stochastic Sudden Stops; Financial crises; Macroprudential policy (search for similar items in EconPapers)
JEL-codes: E31 E37 E52 F41 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2020-06-01
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Journal Article: A Fisherian Approach to Financial Crises: Lessons from the Sudden Stops Literature (2020) Downloads
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