A Dual Liquidity Model for Emerging Markets

10 Pages Posted: 17 Jan 2002

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Arvind Krishnamurthy

Northwestern University - Kellogg School of Management

Multiple version iconThere are 3 versions of this paper

Date Written: January 2002

Abstract

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

Suggested Citation

Caballero, Ricardo J. and Krishnamurthy, Arvind, A Dual Liquidity Model for Emerging Markets (January 2002). Available at SSRN: https://ssrn.com/abstract=297171 or http://dx.doi.org/10.2139/ssrn.297171

Ricardo J. Caballero (Contact Author)

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