Financial Accelerator - Financial Accelerator in Open Economies

Financial Accelerator in Open Economies

The financial accelerator also exists in emerging market crises in the sense that adverse shocks to a small open economy may be amplified by worsening international financial market conditions. Now the link between the real economy and the international financial markets stems from the need for international borrowing; firms’ borrowing to engage in profitable investment and production opportunities, households’ borrowing to smooth consumption when faced with income volatility or even governments’ borrowing from international funds.

Agents in an emerging economy often need external finance but informational frictions or limited commitment can limit their access to international capital markets. The information about the ability and willingness of a borrower to repay its debt is imperfectly observable so that the ability to borrow is often limited. The amount and terms of international borrowing depend on many conditions such as the credit history or default risk, output volatility or country risk, net worth or the value of collateralizable assets and the amount of outstanding liabilities.

An initial shock to productivity, world interest rate or country risk premium may lead to a “sudden stop” of capital inflows which blocks economic activity, accelerating the initial downturn. Or the familiar story of “debt-deflation” amplifies the adverse effects of an asset price shock when agents are highly indebted and the market value of their collateralizable assets deflates dramatically.

Read more about this topic:  Financial Accelerator

Famous quotes containing the words financial and/or open:

    One of the reforms to be carried out during the incoming administration is a change in our monetary and banking laws, so as to secure greater elasticity in the forms of currency available for trade and to prevent the limitations of law from operating to increase the embarrassment of a financial panic.
    William Howard Taft (1857–1930)

    It is open to question whether the highly individualized characters we find in Shakespeare are perhaps not detrimental to the dramatic effect. The human being disappears to the same degree as the individual emerges.
    Franz Grillparzer (1791–1872)