Enrique Mendoza

• University of Pennsylvania

COVID-19 became a global health emergency because it threatened the collapse of health systems as demand for health goods and services and their relative prices surged. Governments responded with lockdowns and transfers. Empirical evidence shows that lockdowns and healthcare saturation contribute to explain the cross-country variation in GDP drops...

Violations of Tinbergen’s rule and strategic interaction undermine stabilization policies in a New Keynesian model with the Bernanke-Gertler accelerator. Welfare costs of risk shocks are large because of efficiency losses and income effects of costly monitoring, but they are much larger under a simple Taylor rule (STR) or a Taylor rule augmented wi...

Infrequent but turbulent sovereign defaults on domestic creditors were a “forgotten history” in macroeconomics. We propose a Bewley model in which the government chooses debt and default on domestic and foreign creditors by balancing distributional incentives versus the benefits of debt for self-insurance, liquidity, and risk-sharing. A feedback me...

Sudden Stops are financial crises defined by a large, sudden current-account reversal. They occur in both advanced and emerging economies and result in deep recessions, collapsing asset prices, and real exchange-rate depreciations. They are preceded by economic expansions, current-account deficits, credit booms, and appreciated asset prices and rea...

We propose a simple and fast fixed-point iteration algorithm (FiPIt) to obtain the global, non-linear solution of macro models with two endogenous state variables and occasionally binding constraints. This method uses fixed-point iteration on Euler equations to avoid solving two simultaneous non-linear equations (as with the time iteration method)...

Global and local methods are widely used in international macroeconomics to analyze incomplete-markets models. We study solutions for an endowment economy, an RBC model and a Sudden Stops model with an occasionally binding credit constraint. First-order, second-order, risky steady state and DynareOBC solutions are compared v. fixed-point-iteration...

“Liability dollarization,” namely intermediation of capital inflows in units of tradables into domestic loans in units of aggregate consumption, adds three important effects driven by real exchange rate fluctuations that alter standard models of Sudden Stops significantly: changes on the debt repayment burden, on the price of new debt, and on a ris...

Collateral constraints widely used in models of financial crises feature a pecuniary externality: Agents do not internalize how borrowing decisions made in “good times” affect collateral prices during a crisis. We show that under commitment the optimal financial regulator’s plans are time inconsistent and study time-consistent policy. Quantitativel...

Since the birth of the Republic, the United States has gone through five debt-crisis episodes defined as year-on-year increases in net federal debt in the 95-percentile. The Great Recession is the second largest, and the only one in which primary deficits continue six years later and are expected to persist at least through 2026. Persistent deficit...

We evaluate the effectiveness of financial policy rules in a small open economy with production, liability dollarization and “unconventional shocks” (global liquidity shifts and news about future fundamentals). Tradable and nontradable final goods are produced with tradable inputs. Debt is denominated in units of tradables and cannot exceed a fract...

The question of what is a sustainable public debt is paramount in the macroeconomic analysis of fiscal policy. This question is usually formulated as asking whether the outstanding public debt and its projected path are consistent with those of the government's revenues and expenditures (ie, whether fiscal solvency conditions hold). We identify cri...

Europe's debt crisis resembles historical episodes of outright default on domestic public debt about which little research exists. This paper proposes a theory of domestic sovereign default based on distributional incentives affecting the welfare of risk-averse debt and nondebtholders. A utilitarian government cannot sustain debt if default is cost...

We study optimal macroprudential policy in a model in which unconventional shocks, in the form of news about future fundamentals and regime changes in world interest rates, interact with collateral constraints in driving the dynamics of financial crises. These shocks strengthen incentives to borrow in good times (i.e. when “good news” about future...

Collateral constraints widely used in models of financial crises feature a pecuniary externality: Agents do not internalize how borrowing decisions taken in “good times” affect collateral prices during a crisis. We show that agents in a competitive equilibrium borrow more than a financial regulator who internalizes this externality. We also find, h...

The question of what is a sustainable public debt is paramount in the macroeconomic analysis of fiscal policy. This question is usually posed as asking whether the outstanding public debt and its projected path are consistent with those of the government's revenues and expenditures (i.e. whether fiscal solvency conditions hold). We identify critica...

In the 1990s, Sudden Stops in emerging markets were a harbinger of the 2008 global financial crisis. During these Sudden Stops, countries lost access to credit, which caused abrupt current account reversals, and suffered severe recessions. This article reviews a class of models that yield quantitative predictions consistent with these observations,...

Global financial imbalances can result from financial integration when countries differ in financial markets development. Countries with more advanced financial markets accumulate foreign liabilities in a gradual, long-lasting process. Differences in financial development also affect the composition of foreign portfolios: countries with negative ne...

We study the short- and long-run effects of financial integration in emerging economies using a two-sector model with a collateral constraint on external debt and trading costs incurred by foreign investors. The probability of a financial crisis displays overshooting: It rises sharply initially and then falls sharply but remains positive in the lon...

What are the stylized facts that characterize the dynamics of credit booms and the associated fluctuations in macro-economic aggregates? This paper answers this question by applying a method proposed in our earlier work for measuring and identifying credit booms to data for 61 emerging and industrialized countries over the 1960-2010 period. We iden...

We test the hypothesis that net foreign asset positions are consistent with external solvency and examine the dynamics of external adjustment using data for 50 countries over the 1970-2006 period. Our analysis adapts Bohn’s (2007) error-correction reaction function approach—which tests for a negative long-run relationship between net exports (NX) a...

This paper investigates whether the international globalization of financial markets allows for significant cross-country risk-sharing at the business cycle frequency. We find that cross-country risk-sharing is still limited and this is unlikely to be the result of financial frictions that limit state-contingent contracts. Part of the limited inter...

The interaction between credit frictions, financial innovation, and a switch from optimistic to pessimistic beliefs played a central role in the 2008 financial crisis. This paper develops a quantitative general equilibrium framework in which this interaction drives the financial amplification mechanism to study the effects of macroprudential policy...

The interaction between credit frictions, financial innovation, and a switch from optimistic to pessimistic beliefs played a central role in the 2008 financial crisis. This paper develops a quantitative general equilibrium framework in which this interaction drives the financial amplification mechanism to study the effects of macro-prudential polic...

Why are episodes of sovereign default accompanied by deep recessions? The existing literature cannot answer this question. On one hand, sovereign default models treat income fluctuations as an exogenous endowment process with ad hoc default costs. On the other hand, emerging markets business cycle models abstract from modeling default and treat def...

Recent evidence on the importance of cross-border equity flows calls for a rethinking of the standard theory of external adjustment. We introduce equity holdings and portfolio choice into an otherwise conventional open-economy dynamic equilibrium model. Our model is simple and it admits an exact closed-form solution regardless of whether financial...

The dominant view in the empirical literature on exchange rates is that the high variability of real exchange rates is due to movements in exchange-rate-adjusted prices of tradable goods. This paper shows that this dominant view does not hold in Mexican data for the periods in which the country had managed exchange rate regimes. Variance analysis o...

Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-hoc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imp...

We contribute to the intense debate on the real effects of fiscal stimuli by showing that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44...

This paper analyzes the efficiency of risk-taking decisions in an economy that is prone to systemic risk, captured by financial amplification effects in response to strong adverse shocks. It shows that decentralized agents who have unconstrained access to a complete set of Arrow securities choose to expose themselves to such risk to a socially inef...

How high can public debt rise without compromising fiscal solvency? We answer this question using a stochastic ability-to-pay model of sovereign default in which risk-neutral investors lend to a government that displays “fiscal fatigue,” because its ability to increase primary balances cannot keep pace with rising debt. As a result, the government...

This paper studies overborrowing, financial crises and macro-prudential policy in an equilibrium model of business cycles and asset prices with collateral constraints. Agents in a decentralized competitive equilibrium do not internalize the negative effects of asset fire-sales on the value of other agents' assets and hence they borrow "too much" ex...

This paper studies overborrowing, flnancial crises and macro-prudential policy in an equilibrium model of business cycles and asset prices with collateral constraints. Agents in a decentralized competitive equilibrium do not internalize the negative efiects of asset flre-sales on the value of other agents’ assets and hence they borrow \too much" ex...

Financial crashes were followed by deep recessions in the Sudden Stops of emerging economies. An equilibrium business cycle model with a collateral constraint explains this phenomenon as a result of the amplification and asymmetry that the constraint induces in the responses of macro-aggregates to shocks. Leverage rises during expansions, and when...

We study overborrowing and financial crises in an equilibrium model of business cycles and asset prices with collateral constraints. Private agents in a decentralized competitive equilibrium do not internalize the effects of their individual borrowing plans on the market price of assets at which collateral is valued and on the wage costs relevant f...

We contribute to the intense debate on the real effects of fiscal stimuli by showing that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44...

Theory predicts that a nation's stochastic intertemporal budget constraint is satisfied if net foreign assets (NFA) are integrated of any finite order, or if net exports (NX) and NFA satisfy an error-correction specification with a residual integrated of any finite order. We test these conditions using data for 21 industrial and 29 emerging economi...

Uncertainty about the riskiness of new financial products was an important factor behind the U.S. credit crisis. We show that a boom-bust cycle in debt, asset prices and consumption characterizes the equilibrium dynamics of a model with a collateral constraint in which agents learn "by observation" the true riskiness of a new financial environment....

Two observations suggest that financial globalization played an important role in the recent financial crisis. First, more than half of the rise in net borrowing of the U.S. non-financial sectors since the mid-1980s has been financed by foreign lending. Second, the collapse of the U.S. housing and mortgage-backed-securities markets had worldwide ef...

Global financial imbalances can result from financial integration when countries differ in financial markets development. Countries with more advanced financial markets accumulate foreign liabilities in a gradual, long-lasting process. Differences in financial development also affect the composition of foreign portfolios: countries with negative ne...

Theory predicts that a nation's stochastic intertemporal budget constraint is satisfied if net foreign assets (NFA) are integrated of any finite order, or if net exports (NX) and NFA satisfy an error-correction specification with a residual integrated of any finite order. We test these conditions using data for 21 industrial and 29 emerging economi...

During the period 1991-93, Finland experienced the deepest economic downturn in an industrialized country since the 1930s. We argue that the culprit behind this Great Depression was the collapse of Finnish trade with the Soviet Union, because it induced a costly restructuring of the manufacturing sector and a sudden, large increase in the cost of e...

We analyze the effects of financial and trade globalization on the likelihood of financial crashes in emerging markets. While trade globalization always makes crashes less likely, financial globalization may make them more likely, especially when trade costs are high. Pessimistic expectations can be self-fulfilling and lead to a collapse in demand...

The ratios of public debt as a share of GDP of Brazil, Colombia and Mexico were 12 percentage points higher on average during the period 1996–2005 than in the period 1990–1995. Costa Rica's debt ratio remained stable but at a high level; near 50 per cent. Is there reason to be concerned about the solvency of the public sector in these economies? We...

We study the characteristics of credit booms in emerging and industrial economies. Macro data show a systematic relationship between credit booms and economic expansions, rising asset prices, real appreciations and widening external deficits. Micro data show a strong association between credit booms and leverage ratios, firm values, and banking fra...

We conduct a cross-country empirical analysis of fiscal solvency based on dynamic stochastic general equilibrium conditions. The results show evidence of fiscal solvency, in the form of a robust positive conditional response of the primary balance to changes in public debt, in panels for emerging and industrial economies and in a combined panel. Em...

Models of business cycles in emerging economies explain the negative correlation between country spreads and output by modeling default risk as an exogenous interest rate on working capital. Models of strategic default explain the cyclical properties of sovereign spreads by assuming an exogenous output cost of default with special features, and the...

During the period 1990-93, Finland experienced the deepest economic downturn in an industrialized country since the 1930s. We argue that the collapse of the Finnish trade with the Soviet Union in and of itself resulted in a large contraction of the economy and a costly restructuring of the manufacturing sector, similar to the transition suffered by...

This paper proposes a methodology for measuring credit booms and uses it to identify credit booms in emerging and industrial economies over the past four decades. In addition, we use event study methods to identify the key empirical regularities of credit booms in macroeconomic aggregates and micro-level data. Macro data show a systematic relations...

Models of business cycles in emerging economies explain the negative correlation between country spreads and output by modeling default risk as an exogenous interest rate on working capital. Models of strategic default explain the cyclical properties of sovereign spreads by assuming an exogenous output cost of default with special features, and the...

We propose a model that solves the crucial disconnect between business cycle models that treat default risk as an exogenous interest rate on working capital, and sovereign default models that treat output ‡uctuations as an exogenous process with ad-hoc default costs. The model explains observed output dynamics around defaults, countercyclical sprea...

Financial globalization had a rocky start in emerging economies hit by Sudden Stops. Foreign reserves have grown very rapidly since then, as if those countries were practicing a New Mercantilism that views foreign reserves as a war chest for defense against Sudden Stops. This paper conducts a quantitative assessment of this argument using a stochas...

Financial globalization had a rocky start in emerging economies hit by Sudden Stops. Foreign reserves have grown very rapidly since then, as if those countries were practicing a New Mercantilism that views foreign reserves as a war-chest for defense against Sudden Stops. This paper conducts a quantitative assessment of this argument using a stochas...

According to the “Saving Glut hypothesis”, global imbalances are caused by inefficiently high level of precautionary savings in financially underdeveloped regions, where agents have limited opportunity to diversify idiosyncratic risk. This paper generalizes the approach by modeling idiosyncratic risk in entrepreneurial activities, which can be only...

Financial globalization was off to a rocky start in emerging economies hit by Sudden Stops in the 1990s. The surge in foreign reserves since then is viewed as a New Merchantilism in which reserves are a war-chest for defense against Sudden Stops. We conduct a quantitative assessment of this argument using a framework in which precautionary savings...

Financial globalization was off to a rocky start in emerging economies hit by Sudden Stops since the mid 1990s. Foreign reserves grew very rapidly during this period, and hence it is often argued that we live in the era of a New Merchantilism in which large stocks of reserves are a war-chest for defense against Sudden Stops. We conduct a quantitati...

This paper looks at fiscal solvency and public debt sustainability in both emerging market and advanced countries. Evidence of fiscal solvency, in the form of a robust positive conditional relationship between public debt and the primary fiscal balance, is established in both groups of countries. Evidence of fiscal solvency is much weaker, however,...

Large and persistent global financial imbalances need not be the harbinger of a world financial crash. Instead, we show that these imbalances can be the outcome of financial integration when countries differ in financial markets deepness. In particular, countries with more advanced financial markets accumulate foreign liabilities in a gradual, long...

This paper shows that the quantitative predictions of an equilibrium asset-pricing model with financial frictions are consistent with key features of the Sudden Stop phenomenon. Foreign traders incur costs in trading assets with domestic agents, and a collateral constraint limits external debt to a fraction of the market value of domestic equity ho...

An implication of the globalization hazard hypothesis is that ‘Sudden Stops’ caused by global financial frictions could be prevented by offering foreign investors price guarantees on emerging markets assets. These guarantees create a tradeoff, however, because they weaken globalization hazard while creating international moral hazard. We study this...

This paper reports results for a class of dynamic, stochastic general equilibrium models with credit constraints that can account for some of the empirical regularities of the Sudden Stop phenomenon of recent emerging markets crises. In these models, credit constraints set in motion Irving Fisher's debt-deflation mechanism and they bind as an endog...

We introduce a new hybrid approach to joint estimation of Value at Risk (VaR) and Expected Shortfall (ES) for high quantiles of return distributions. We investigate the relative performance of VaR and ES models using daily returns for sixteen stock market indices (eight from developed and eight from emerging markets) prior to and during the 2008 fi...