Financial Distortions and the Distribution of Global Volatility
Why are emerging economies excessively vulnerable to shocks to external funding? What was the role of financial flows from emerging to developed economies in setting the stage for the subprime crisis? This paper addresses these questions in a simpl...
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| Language: | English |
| Published: |
2012
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| Online Access: | http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20120103114938 http://hdl.handle.net/10986/3215 |
| Summary: | Why are emerging economies excessively
vulnerable to shocks to external funding? What was the role
of financial flows from emerging to developed economies in
setting the stage for the subprime crisis? This paper
addresses these questions in a simple general equilibrium
framework that emphasizes the aggregate implications of the
misallocation of funds on the micro level. The analysis
shows that the misallocation of funds amplifies volatility
even in a closed economy. Financial integration between
relatively distorted emerging economies and relatively
undistorted developed economies leads to a further
divergence in volatility, thereby providing a new and simple
explanation for the divergent trends in output volatility up
to the recent crisis. In the integrated environment, cheap
funding leads to an endogenous deterioration of the
financial system in developed economies. These predictions
are consistent with a wide variety of microfoundations, in
which distortions cause productive projects to be relatively
more sensitive to aggregate shocks. The paper provides some
empirical evidence for these microfoundations. |
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