Sudden stops, sectoral reallocations, and the real exchange rate

Abstract

a b s t r a c t JEL classification: E21 F21 F32 F34 F43 O41 O47 O54 Keywords: Sudden stop Developing country crisis Real exchange rate Tradable Nontradable Mexico Total factor productivityA sudden stop of capital flows into a developing country tends to be followed by a rapid switch from trade deficits to surpluses, a depreciation of the real exchange rate, and decreases in output and total factor productivity. Substantial reallocation takes place from the nontraded sector to the traded sector. We construct a multisector growth model, calibrate it to the Mexican economy, and use it to analyze Mexico's 1994-95 crisis. When subjected to a sudden stop, the model accounts for the trade balance reversal and the real exchange rate depreciation, but it cannot account for the decreases in GDP and TFP. Extending the model to include labor frictions and variable capital utilization, we still find that it cannot quantitatively account for the dynamics of output and productivity without losing the ability to account for the movements of other variables.

Real exchange rate fluctuations, wage stickiness and tradability

“…The 10% gap could be partially attributed to the contribution of the relative price of capital, since in practice some capital goods are traded, as documented in Alfaro and Hammel (). In addition, our finding that the relative wage plays a crucial role in short‐run adjustments of the RER is in line with the studies that highlight the importance of labour market frictions in open economies by Kehoe and Ruhl () and Gorodnichenko et al ().…”

Emerging Market Business Cycles: The Role of Labor Market Frictions

“…Empirically, matching efficiency shocks can be motivated by the following observations regarding Sudden Stop episodes. Kehoe and Ruhl () document that substantial reallocations, which are often costly, take place from nontradable to tradable goods sectors following Sudden Stops. For example, in the aftermath of the Mexican crisis in 1994–95, massive sectoral reallocations took place as the depreciation of real exchange rates drove down the relative price of nontradable goods.…”

“…Recent evidence emphasizes the importance of labor markets for understanding macroeconomic dynamics specific to emerging market economies (EMEs), including recovery from financial crises and output fluctuations (see Bergoeing et al. , Kehoe and Ruhl ). Despite the rapid development of emerging market business cycle models over the past decade—which, in general, aim to explain large swings in consumption relative to output and countercyclical current account dynamics prevalent in EMEs—we have limited understanding of the labor market dynamics in these countries and their role in business cycle fluctuations .…”

Sudden stops and output: an empirical Markov switching analysis

“…This definition is also used in Calvo et al (2006c) and Bordo et al (2010). 2 Examples of the DSGE literature related to the sudden stop phenomenon include Mendoza and Smith (2002), Gopinath (2004), Chari et al (2005), Neumeyer and Perri (2005), Cook and Devereux (2006), Jaimovich and Rebelo (2008), Braggion et al (2009), Kehoe and Ruhl (2009), and Mendoza (2010). in a "normal" regime.…”