Financial Frictions and Total Factor Productivity: Accounting for the Real Effects of Financial Crises

Sangeeta Pratap and Carlos Urrutia ()

No 429, Economics Working Paper Archive at Hunter College from Hunter College Department of Economics

Abstract: The financial crises or “sudden stops” of the last decade in emerging economies were accompanied by a large fall in total factor productivity. In this paper we explore the role of financial frictions in exacerbating the misallocation of resources and explaining this drop in TFP. We build a dynamic two-sector model of a small open economy with a cash in advance constraint where firms have to finance a part of their purchase of intermediate goods prior to production. The model is calibrated to the Mexican economy before the 1995 crisis and subject to an unexpected shock to interest rates. The financial friction can generate an endogenous fall in TFP of about 3.5 percent and can explain 74 percent of the observed fall in GDP per worker. Adding a cost of adjusting labor between the two sectors and sectoral specificity of capital also generates the sectoral patterns of output and resource use observed in the data after the sudden stop. The results highlight the interaction between interest rates and allocative inefficiencies as an explanation of the real effects of the financial crisis.

Keywords: Financial frictions; labor market turbulence; adjustment costs; sudden stops; total factor productivity; output fluctuations (search for similar items in EconPapers)
JEL-codes: D14 D43 D91 (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-bec, nep-cba, nep-dge and nep-eff
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Financial Frictions and Total Factor Productivity: Accounting for the Real Effects of Financial Crises (2012)
Working Paper: Financial Frictions and Total Factor Productivity: Accounting for the Real Effects of Financial Crises (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:htr:hcecon:429

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