Growth Effects in a Stochastic Model of Currency Crisis
UCSC Dept. of Econ. Working Paper No. 481
35 Pages Posted: 26 Oct 2001
Date Written: September 22, 2001
The main contributions of this paper are to introduce growth into a crisis framework and to derive the contingency plans for consumption and investment in a manner consistent with the stochastic nature of the state of the economy. The conclusion is that expected deviations from trend in the future rate of depreciation do reduce domestic investment and growth. Empirical evidence in support of this idea is also presented. While the intuition behind the "crowding out" effect of expected increases in government spending on domestic investment is familiar to any student of intermediate macroeconomics, formalizing this notion in the context of a crisis is an important step towards understanding a potential source of output losses. An implicit assumption is that markets of contingent claims are incomplete, so that private agents are unable to insure away the adverse income effects of the fiscal expansion.
Keywords: Stochastic model, growth, currency crisis
JEL Classification: C61, E63, F31, F43
Suggested Citation: Suggested Citation