A dual liquidity model for emerging markets

Description

The last few years have seen a significant re-evaluation of the models used to analyze crises in emerging markets. Recent models typically stress financial constraints or distorted financial incentives. While this certainly represents progress, these models share a weakness with the earlier work: neither is uniquely about emerging markets. Adaptations of the Mundell-Fleming model represent Argentina as a Belgium with larger external shocks. Likewise, emerging market models of financial constraints are adaptations of developed economy ones with tighter financial constraints. In our work, we have advocated a model that distinguishes between the financial constraints affecting borrowing and lending among agents within an emerging economy, and those affecting borrowing from foreign lenders. This "dual liquidity" model offers a parsimonious description of the behavior of firms, governments, and asset prices during financial crises. It also provides prescriptions for optimal policy responses to these crises. Keywords: Capital flows, external crises, international and domestic liquidity, monetary policy, fiscal policy, underinsurance. JEL Classification: E0, E4, E5, F0, F3, F4, G1.

Subjects

Series Statement

• Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 02-03
• Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 02-03.

Links

• http://ssrn.com/abstract=297171