Credit Constraints and the North-South Transmission of Crises
Adverse shocks to rich countries often have a large and persistent negative impact on investment and output in developing countries. This paper examines a transmission mechanism that can account for this stylized fact. The mechanism is based on the...
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| Format: | Policy Research Working Paper |
| Language: | English |
| Published: |
2012
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| Subjects: | |
| Online Access: | http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20100830130101 http://hdl.handle.net/10986/3893 |
| Summary: | Adverse shocks to rich countries often
have a large and persistent negative impact on investment
and output in developing countries. This paper examines a
transmission mechanism that can account for this stylized
fact. The mechanism is based on the existence of
international financial frictions. Specifically, if a small,
developing country has to collateralize its assets to borrow
funds to invest, falling asset prices caused by a negative
shock in an advanced economy worsen the developing
country's collateral value and reduce its ability to
borrow and reinvest. Hence, investment in the developing
country declines, and international investors repatriate
capital to the advanced country. As less capital now can be
pledged as collateral, the developing country's credit
constraint is further tightened, which leads to another
round of decline in investment. This generates a downward
spiral that may cause large output losses to the developing
country. The mechanism finds empirical support in the
2008-2009 crisis data. |
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