Crises, Volatility, and Growth

When credit is constrained, a bias toward short-term debt can arise in financing long-term investments, generating maturity mismatches and leading potentially to liquidity crises. After the financial crises of the 1990s many voices rose to explain that the causes of these crises were new (Radelet an...

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Main Author:	Kharroubi, Enisse
Format:	Journal Article
Published:	World Bank 2012
Subjects:	corporate debt economic development financial crises Financial development financial markets International Monetary Fund liquidity crises Macroeconomics normal volatility Volatility
Online Access:	http://hdl.handle.net/10986/4465

id	okr-10986-4465
recordtype	oai_dc
spelling	okr-10986-44652021-04-23T14:02:18Z Crises, Volatility, and Growth Kharroubi, Enisse corporate debt economic development financial crises Financial development financial markets International Monetary Fund liquidity crises Macroeconomics normal volatility Volatility When credit is constrained, a bias toward short-term debt can arise in financing long-term investments, generating maturity mismatches and leading potentially to liquidity crises. After the financial crises of the 1990s many voices rose to explain that the causes of these crises were new (Radelet and Sachs 1998; Corsetti, Pesenti, and Roubini 1999). According to the first, "crony capitalism" can explain the imbalances (Krugman 1999), because in distorting individual incentives, it encouraged firms to make inefficient decisions (about investments, risks, and so on). Understanding how economic and financial development modifies financial contracts requires understanding original sin. THE MACROECONOMIC MOD EL This section introduces this capital market framework in a macroeconomic model to shed light on the aggregate consequences of the structure of financial contracts. Long-term contracts are imperfectly enforceable; default is possible, but an entrepreneur needs to pay a marginal cost on the final output (t when the entrepreneur can carry out an illiquid long-term project and t when the entrepreneur violates the illiquidity constraint and reinvests in the storage technology). The case where entrepreneurs pay for their debts if and only if they can carry out their illiquid project until maturity (not considered here) is always dominated; entrepreneurs have to pay for default costs and there are no benefits for the debt portfolio (size being identical and risk premium being actuarially fair). These two sources of aggregate volatility reduce growth through independent channels; the probability of a run reduces the average return on the entrepreneur's projects, whereas the volatility R 2 r on the return on entrepreneur's projects increases the average return on the entrepreneur's projects but imposes a negative effect on the storage technology that always dominates at the aggregate level. Interaction Effects of Financial Development and Different Volatility Measures Dependent variable: GDP per capita growth Regression 1 Log of initial GDP per capita Population growth Credit to GDP Growth volatility Low-growth frequency Growth volatility Â credit to GDP Low-growth frequency Â credit to GDP Hausman test (p-value) Sargan test (p-value) Number of observations 2 3 4 5 6 20.965 20.728* 20.657 20.738* 20.790* 20.995 20.894* 20.634 20.774* 20.506 21.974* 20.724* -- 1 À a l ars m t 458 THE WORLD BANK ECONOMIC REVIEW If an entrepreneurs can carry out a project in the production technology with a debt portfolio (a,m), it is then incentive-compatible to exchange this portfolio against a portfolio (b,m) if and only if (1 m 2 bmrs)R 2 2 t). 2012-03-30T07:12:36Z 2012-03-30T07:12:36Z 2007-09-30 Journal Article World Bank Economic Review 1564-698X http://hdl.handle.net/10986/4465 CC BY-NC-ND 3.0 IGO http://creativecommons.org/licenses/by-nc-nd/3.0/igo World Bank World Bank Journal Article China Ecuador Congo, Republic of Nigeria
repository_type	Digital Repository
institution_category	Foreign Institution
institution	Digital Repositories
building	World Bank Open Knowledge Repository
collection	World Bank
topic	corporate debt economic development financial crises Financial development financial markets International Monetary Fund liquidity crises Macroeconomics normal volatility Volatility
spellingShingle	corporate debt economic development financial crises Financial development financial markets International Monetary Fund liquidity crises Macroeconomics normal volatility Volatility Kharroubi, Enisse Crises, Volatility, and Growth
geographic_facet	China Ecuador Congo, Republic of Nigeria
description	When credit is constrained, a bias toward short-term debt can arise in financing long-term investments, generating maturity mismatches and leading potentially to liquidity crises. After the financial crises of the 1990s many voices rose to explain that the causes of these crises were new (Radelet and Sachs 1998; Corsetti, Pesenti, and Roubini 1999). According to the first, "crony capitalism" can explain the imbalances (Krugman 1999), because in distorting individual incentives, it encouraged firms to make inefficient decisions (about investments, risks, and so on). Understanding how economic and financial development modifies financial contracts requires understanding original sin. THE MACROECONOMIC MOD EL This section introduces this capital market framework in a macroeconomic model to shed light on the aggregate consequences of the structure of financial contracts. Long-term contracts are imperfectly enforceable; default is possible, but an entrepreneur needs to pay a marginal cost on the final output (t when the entrepreneur can carry out an illiquid long-term project and t when the entrepreneur violates the illiquidity constraint and reinvests in the storage technology). The case where entrepreneurs pay for their debts if and only if they can carry out their illiquid project until maturity (not considered here) is always dominated; entrepreneurs have to pay for default costs and there are no benefits for the debt portfolio (size being identical and risk premium being actuarially fair). These two sources of aggregate volatility reduce growth through independent channels; the probability of a run reduces the average return on the entrepreneur's projects, whereas the volatility R 2 r on the return on entrepreneur's projects increases the average return on the entrepreneur's projects but imposes a negative effect on the storage technology that always dominates at the aggregate level. Interaction Effects of Financial Development and Different Volatility Measures Dependent variable: GDP per capita growth Regression 1 Log of initial GDP per capita Population growth Credit to GDP Growth volatility Low-growth frequency Growth volatility Â credit to GDP Low-growth frequency Â credit to GDP Hausman test (p-value) Sargan test (p-value) Number of observations 2 3 4 5 6 20.965 20.728* 20.657 20.738* 20.790* 20.995 20.894* 20.634 20.774* 20.506 21.974* 20.724* -- 1 À a l ars m t 458 THE WORLD BANK ECONOMIC REVIEW If an entrepreneurs can carry out a project in the production technology with a debt portfolio (a,m), it is then incentive-compatible to exchange this portfolio against a portfolio (b,m) if and only if (1 m 2 bmrs)R 2 2 t).
format	Journal Article
author	Kharroubi, Enisse
author_facet	Kharroubi, Enisse
author_sort	Kharroubi, Enisse
title	Crises, Volatility, and Growth
title_short	Crises, Volatility, and Growth
title_full	Crises, Volatility, and Growth
title_fullStr	Crises, Volatility, and Growth
title_full_unstemmed	Crises, Volatility, and Growth
title_sort	crises, volatility, and growth
publisher	World Bank
publishDate	2012
url	http://hdl.handle.net/10986/4465
_version_	1764391484778348544

Crises, Volatility, and Growth

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