Akiko Terada Balance Sheet Effects and Financial Propagation: Evidence from Industrial and Emerging Markets

This paper examines the balance sheet effects with particular attention to the development of the financial system. Our results indicate that the macroeconomic cycles are more volatile in financially underdeveloped economies. We also found that net worth measured by stock prices plays a role in propagating real and credit cycles. The sensitivity to the change in net worth is particularly large in financially underdeveloped economies. Asymmetric behavior of the responses across boom and crash periods is found to be significant with production and credit cycles associated with the low level of financial development. This evidence supports the prediction of financial propagation mechanism caused by the balance sheet effects. Key word: Financial propagation, Balance sheet effect, and Credit booms JEL classification: F2, F4, E3 1 I thank Graciela Kaminsky, Holger Wolf, Fred Joutz, Jorge Soares, Sylvain Leduc, and participants at the Fall 2000 Macro-International seminar at George Washington University and the Bank of Japan for many helpful comments. I benefited from a discussion with Pamela Labadie at earlier stage of the paper. I am also grateful to the participants of the Friday international meeting for their suggestions and support.