Elisabeth Huybens

Inflation, financial markets and long-run real activity

Empirical evidence suggest that real activity, the volume of bank lending activity, and the volume of trading in equity markets are strongly positively correlated. At the same time. inflation and the volume of financial market activity are strongly negatively correlated (in the long-run), as are inflation and the real rate of return on equity. Inflation anr real activity are also negatively correlated in the long-run, particularly for economies with relatively high rates of inflation. We present a monetary growth model in which banks and secundary capital markets play a crucial allocative function. We show that - at least under certain configurations of parameters - the predictions of the model are consistent with these and several other observations about finance, inflation and long-run real activity.

Financial Market Discipline in Early-Twentieth-Century Mexico

We test for the presence of market discipline in the banking sector in early-twentieth-century Mexico. Using financial data from note-issuing banks between 1900 and 1910, we examine whether bank fundamentals influenced the patterns of withdrawals and of note issue. We show that fundamentals were a strong determinant of bank withdrawals and note issue, indicating that market discipline was an important feature of the banking system in this period. This result crucially depends on correcting for selection bias generated by the exit of several banks in the 1907 crisis.

Domestic financial market frictions, unrestricted international capital flows, and crises in small open economies*

We present an example of a small open economy for which small increases in the world interest rate may induce a sharp decline in output and a precipitous depreciation of the nominal and the real exchange rate (RER). Due to a costly state verification problem in domestic credit markets, combined with unrestricted international capital flows, our economy generates two long run equilibria, one with low GDP and a relatively depreciated RER, and one with high GDP and a relatively appreciated RER. The first is always a saddle, while the second may be a sink or a source, depending on the level of the world interest rate. There exists a critical level of the world interest rate above which the high-GDP steady state turns from a sink to a source. A “crisis” is identified in the model with the economy switching from an equilibrium path approaching the high-output steady state to the saddle path approaching the low output steady state. We simulate such a crisis trajectory for our model economy. In Mexico’s recent history, periods of growth associated with an appreciation of the real exchange rate (RER) have alternated with periods of sharp contraction characterized by a depreciation of the RER. Our economy may display such behavior as an equilibrium response to changes in the world interest rate.