Abstract:
Using a sample of emerging markets that are integrated into global bond markets, we
analyse the collapse and recovery phase of output collapses that coincide with systemic
sudden stops, defined as periods of skyrocketing aggregate bond spreads and large capital
flow reversals. Our findings indicate the presence of a very similar pattern across different
episodes: output recovers with virtually no recovery in either domestic or foreign credit, a
phenomenon that we call Phoenix Miracle, where output "rises from its ashes", suggesting
that firms go through a process of financial engineering to restore liquidity outside the formal
credit markets. Moreover, we show that the US Great Depression could be catalogued as a
Phoenix Miracle. However, in contrast to the US Great Depression, EM output collapses
occur in a context of accelerating price inflation and falling real wages, casting doubts on
price deflation and nominal wage rigidity as key elements in explaining output collapse, and
suggesting that financial factors are prominent for understanding these collapses.
(This paper includes comments by Takatoshi Ito.)