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The Role of Expectations in Sudden Stops

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Author Info
Karel Mertens

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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.

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Paper provided by European University Institute in its series Economics Working Papers with number ECO2007/16.

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Date of creation: 2007
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Handle: RePEc:eui:euiwps:eco2007/16

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Related research
Keywords: sudden stops; small open economy; expectations; peso problem;

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Find related papers by JEL classification:
E2 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
F3 - International Economics - - International Finance
F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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  16. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "What caused the Asian currency and financial crisis?," Japan and the World Economy, Elsevier, vol. 11(3), pages 305-373, October. [Downloadable!] (restricted)
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  17. Correia, I. & Rabelo, S. & Naves, J.C., 1994. "Business Cycles in a Small Open Economy," RCER Working Papers 382, University of Rochester - Center for Economic Research (RCER).
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  28. Roberto Chang & Andrés Velasco, 2001. "A Model Of Financial Crises In Emerging Markets," The Quarterly Journal of Economics, MIT Press, vol. 116(2), pages 489-517, May. [Downloadable!] (restricted)
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