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wiiw Seminar in
International Economics |
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Financial Crisis, Capital Liquidation and the Demand for
International Reserves
Alex Mourmouras, IMF
(with Steven H. Russell)
29 October 2009, 4 p.m. |
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| Seminar
organized in cooperation with the Joint Vienna Institute |
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| We study
a simple neoclassical model of investment in a developing country,
modified to allow for long-term projects and short-term debt.
Early signals indicating low productivity of investment may
lead creditors to call loans in early. In such a crisis, firms
protected by limited liability default and liquidate capital,
even though they do so at a loss (a “fire sale”). We show that
short-term debt financing is beneficial in good (normal) times:
when there is no adverse signal, and thus no need to liquidate
capital, investment, the capital-labor ratio, wages and ex post
worker utility are all higher than they would be if liquidation
were not possible or was prohibited. Capital liquidation exacerbates
the effects of negative shocks by lowering the capital-labor
ratio and lowering wages in bad times (crises). Capital liquidation
raises the variability of wages and hurts workers who cannot
insure against wage income (this seems plausible in emerging
market economies). Accumulating a stock of international reserves
to be used during or after a crisis can mitigate the adverse
effects of capital liquidation on wage variability and worker
welfare. |
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