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Memory, multiple equilibria and emerging market crises

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  • Pierri, Damian Rene
  • Reffett, Kevin
Abstract
We present a new Generalized Markov Equilibrium (GME) approach to studying sudden stops and financial crises in emerging countries in the canonical small open economy model with equilibrium price-dependent collateral constraints. Our approach to characterizing and computing stochastic equilibrium dynamics is global, encompasses recursive equilibrium as a special case, yet allows for a much more flexible approach to modeling memory in such models that are known to have multiple equilibrium. We prove the existence of ergodic GME selections from the set of sequential competitive equilibrium, and show that at the same time ergodic GME selectors can replicate all the observed phases of the macro crises associated with a sudden stop (boom, collapse, spiralized recession, recovery) while still being able to capture the long-run stylized behavior of the data. We also compute stochastic equilibrium dynamics associated with stationary and nonstationary GME selections, and we find that a) the ergodic GME selectors generate stochastic dynamics that are less financially constrained with respect to stationary non-ergodic paths, b) non-stationary GME selections exhibit a great range of fluctuations in macroeconomic aggregates compared to the stationary selections. From a theoretical perspective, we prove the existence of both sequential competitive equilibrium and (minimal state space) recursive equilibrium, as well as provide a complete theory of robust recursive equilibrium comparative statics in deep parameters. Consistent with recent results in the literature, relative to the set of recursive equilibrium, we find 2 stationary equilibrium: one with high/over borrowing, the other with low/under borrowing. These equilibrium are extremal and “selffulfilling” under rational expectations. The selection among these equilibria depend on observable variables and not on sunspots.

Suggested Citation

  • Pierri, Damian Rene & Reffett, Kevin, 2021. "Memory, multiple equilibria and emerging market crises," UC3M Working papers. Economics 32871, Universidad Carlos III de Madrid. Departamento de Economía.
    • Handle: RePEc:cte:werepe:32871
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    Cited by:

    1. Pierri Damian, 2024. "Accuracy in Recursive Minimal State Space Methods," Computational Economics, Springer;Society for Computational Economics, vol. 64(1), pages 263-305, July.
    2. Pierri, Damian Rene & Montes Rojas, Gabriel & Mira, José, 2020. "Persistent current account deficits and balance of payments crises," UC3M Working papers. Economics 34239, Universidad Carlos III de Madrid. Departamento de Economía.
    3. Damián Pierri & Hernán D. Seoane, 2022. "An Ergodic Theory of Sovereign Default," Working Papers 206, Red Nacional de Investigadores en Economía (RedNIE).

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    Keywords

    Financial Crises;

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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