Sectoral Asymmetries, Currency Mismatch And Sudden Stops

Recent financial crises in developing countries have exhibited sharp falls in capital flows, i.e. sudden stops and accompanying large output drops. Several models have tried to connect these two facts quantitatively. Since sudden stops cannot generate large output drops quantitatively, these models introduce other frictions that have little supporting evidence. In this paper, the authors present a two-sector model where there is an amplification mechanism generated by two frictions: borrowing constraints; and currency mismatch in non-tradable sector. To support the existence of these distortions they construct a micro data set for Turkey, and show that both non-tradable and tradable sectors of the economy are borrowing constrained with non-tradable sector's investment being more responsive to their internal funds.