Determining underlying macroeconomic fundamentals during emerging market crises: Are conditions as bad as they seem?

Emerging market crises are characterized by large swings in both macroeconomic fundamentals and asset prices. The economic significance of observed movements in macroeconomic variables is obscured by the brief and extreme nature of crises. In this paper we propose to study the macroeconomic consequences of crises by studying the behavior of ‘‘effective’’ fundamentals, constructed by studying the relative movements of stock prices during crises. We find that these effective fundamentals provide a different picture than that implied by observed fundamentals. First, asset prices often reflect expectations of improvement in fundamentals after the initial devaluations; specifically, effective depreciations are positive but not as large as the observed ones. Second, crises vary in their effect on credit market conditions, with investors expecting tightening of credit in some see front matter r 2006 Elsevier B.V. All rights reserved. .jmoneco.2005.02.005 k Daron Acemoglu, Ricardo Caballero, Guillermo Calvo, Rudi Dornbusch, Roberto Rigobon, ra, Alwyn Young, an anonymous referee, and participants of seminars at MIT, University of iversity of Maryland, and University of Michigan for their helpful comments. We also thank Daniel aluable research assistance. All remaining errors are ours. Aguiar thanks the Sloan Foundation and B for research support. Broner thanks the Ministerio de Ciencia y Tecnologı́a de España, Plan I+D+I and FEDER (ref: SEC2002-03816), the Generalitat de Catalunya, and CREA-Barcelona or financial support. The views expressed in this paper are not necessarily those of the Federal k of Boston or the Federal Reserve System. nding author. Tel.: +3493 542 2601; fax: +34 93 542 1860. dresses: [email protected] (M. Aguiar), [email protected] (F.A. Broner). ARTICLE IN PRESS M. Aguiar, F.A. Broner / Journal of Monetary Economics 53 (2006) 699–724 700 cases (Mexico 1994, Philippines 1997), but loosening of credit in others (Sweden 1992, Korea 1997, Brazil 1999). r 2006 Elsevier B.V. All rights reserved.