Bankruptcy Costs, Liability Dollarization, and Vulnerability to Sudden Stops
University of Connecticut
Amherst College - Department of Economics
April 1, 2010
Journal of Development Economics, Forthcoming
Countries with intermediate levels of institutional quality suffer larger output contractions following sudden stops of capital inflows than less developed nations. However, countries with strong institutions seldom experience significant falls in output after capital flow reversals. We reconcile these two observations using a calibrated DSGE model that extends the financial accelerator framework developed in Bernanke, Gertler, and Gilchrist (1999). The model captures financial market institutional quality with creditors’ ability to recover assets from bankrupt firms. Bankruptcy costs affect vulnerability to sudden stops directly but also indirectly by affecting the degree of liability dollarization. Simulations reveal an inverted U-shaped relationship between bankruptcy costs and the output loss following sudden stops.
Number of Pages in PDF File: 31
Keywords: sudden stops, bankruptcy costs, financial accelerator, liability dollarization
JEL Classification: E44, F31, F41, O16
Date posted: September 8, 2010
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