The Credit Channel in Middle Income Countries

59 Pages Posted: 6 Dec 2002 Last revised: 30 Oct 2010

See all articles by Aaron Tornell

Aaron Tornell

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Frank Westermann

University of Osnabrueck - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute

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Date Written: December 2002

Abstract

Credit market conditions play a key role in propagating shocks in middle income countries (MICs). In particular, shocks to the spread between domestic and international interest rates have a strong effect on GDP, and an even stronger effect on domestic credit. This strong credit channel is associated with a sharp sectorial asymmetry: the output of the bank-dependent nontradables (N) sector reacts more strongly than tradables (T) output. This asymmetry, in turn, is associated with a strong reaction of the real exchange rate --the relative price between N and T goods. We present a model that reconciles these facts and leads to a well specified estimation framework. From the equilibrium we derive structural VARs that allow us to identify shocks to credit market conditions and trace their effects on the economy. We estimate these structural VARs for a group of MICs and find evidence of a strong credit channel. We argue that at the heart of the MIC credit channel are a deep asymmetry in financing opportunities across N and T sectors, and a severe currency mismatch. This makes movements in the real exchange rate the driving element in the amplification of shocks. Finally, we show that the model's key assumptions are consistent with evidence gleaned from both firm level and aggregate data.

Suggested Citation

Tornell, Aaron and Westermann, Frank, The Credit Channel in Middle Income Countries (December 2002). NBER Working Paper No. w9355. Available at SSRN: https://ssrn.com/abstract=359840

Aaron Tornell (Contact Author)

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Frank Westermann

University of Osnabrueck - Department of Economics ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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Munich, 01069
Germany

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