Boom-Bust Cycles : Facts and Explanation

There is a remarkable similarity across middle income countries in the patterns of macroeconomic variables around twin crises: there is a common boom-bust cycle. We characterize this cycle empirically. We find that prior to a twin currency and banking crisis the typical country experiences a real appreciation and a lending boom along which credit grows unusually fast. Puzzlingly, in the aftermath of a crisis there is typically a short-lived recession and a protracted credit crunch that persists long after aggregate growth has resumed. This pattern can be explained by the fact that the credit crunch mainly hits nontradables firms (N). In fact, for several years after the crisis N-production declines relative to the output of the tradable T-sector. These comovements indicate that ‘currency mismatch’ and asymmetric financing opportunities across sectors play important roles in middle income countries. We present a model where these elements play a key role and where the comovements alluded to above arise along the equilibrium path.