The Role of Credit in Post-Stabilization Consumption Booms

Boardof Governorsof the FederalReserveSystem InternationalFinanceDiscussionPapers Number569 October 1996 THE ROLEOF CREDITIN POST-STABILIZATIONCONSUMPTIONBOOMS MartinaCopelman NOTE: InternationalFinanceDiscussionPapersare preliminarymaterialscirculatedto stimulate discussionandcriticalcomment. Referencesinpublicationsto InternationalFinanceDiscussion Papers(otherthanan acknowledgmentthatthewriter hashad accessto unpublishedmaterial)should be clearedwiththeauthoror authors.

BSTRACT Thispaper presentsan empiricalinvestigationof the roleof creditinthepost-stabilization consumptionboomsof Mexico,Chile,andIsrael. Creditfrom thebankingsectorto theprivatesector expandedvery rapidlyfollowingthestabilizations. I showthatthis increaseincreditreducedthe proportionof consumersthatwere liquidityconstrainedintheeconomy. Thisreductionin liquidity constraintscouldhavehelpedto fiel theobservedconsumptionbooms. In addition,I showthatthe mostimportantchannelsfor theexpansionincreditto consumersin Mexicoare therapid remonetizationof the economy,the fallintheratioofdebtheldby banksto GDP heldby banks, and theincreasein the foreignliabilitiesofbanks. For Chile,themost importantchannelisthe remonetizationof the economy,whereasinIsrael, it isthecrowdingin effectfromthefall inthe ratio ofpublicdebtheldby banksto GDP. Thefactthatonlythecrowdingineffectwas importantfor Israel. isexplainedby thedifferencesbetweenitsbankingsystemandthoseof theothercountries.

The RoleofCredit in Post-StabilizationConsumptionBooms MartinaCopelmanl This paperpresentsempiricalevidencethattheexpansionof credit, in particularbankcredit, reducesliquidityconstraintsofconsumersafier stabilizations. Thisreductionin liquidityconstraints can helpexplaintheconsumptionboomsobservedin Chile,Mexico,andIsraelfollowingtheir stabilizationprograms. Conventionalwisdommaintainsthatdisinflationscanhavestrongcontractionaryeffects. Estimatesfor the “sacrificeratio”inthe U.S. liebetween3 and 18.(Sachs(1985))2 These pessimisticevidencehaveusuallybeenbasedon evidencefrommoney-basedstabilizations. Sargent(1982)challengesthisviewusingevidencefrom thedisinflationprogramsof the early 1920’s Europeanhyperinflations. Recently.Kigueland Liviatan(1992)haveshownthattheprogramsin LatinAmericaand in Israelduringthemid 1980’shaveactuallybeenexpansionary. The expansionaryinitialphaseisdrivenby a consumption.andsometimes,an investment boom. Thecharacteristics of thesestabilizationsincludea largeinitialdevaluationanda subsequent fixingof the exchangerate. Sincetheyusethe exchangerateas thenominalanchor, theyare usually calledexchangeratebased, ERB,stabilizations. Fromthebegiming oftheprogramto the quarter whenconsumptionpeaked,totalconsumptionincreasedby 34%inChile,38% in Israel, and25% in ‘ Theauthors isstaffeconomistintheDivisionofInternational Finance, BoardofGovernorsoftheFederal Reserve System. Theviewsexpressed inthispaper are solelytheresponsibility oftheauthor andshouldnotbeinterpreted as reflecting thoseofthe BoardofGovernors ofthe Federal Reserve Systemor other members of itsstaff. Iamgrateful toRudiger Dornbusch, Gustavo Canonero. LuisHerrera, PaulKrugman.RobertSoloW.AlejandroWerner, andtheparticipantsoftheM.I.T. International Breakfas[ andthe Money Lunchas wellas theparticipants ofthe seminars at the Federal Reserve Boardfor manyhelpful suggestions and comments. 2Thesacrifice ratio isdefined as the cumulative percent output loss per percentage pointreduction ininflation.

Mexico.3 Privateconsumptionin Mexicoincreasedat an averagereal annualrateof 5.8% during 1989-92,at 4.3% inChilebetween 1978and 1982,and at 11%in Israelbetween 1985and 1987. Figures 1,2, and 3 showthe increasein realper capitaprivateconsumptionineachcountry. FIGURE 1 ..’ MEXICOPRIVATECONSUMPTION 4.65 4.60 4.55 4.50 c 4.45. I 1 83 1 f [ 1 84 1 t 8 I 5 I 86 87 88 89 ’90 91 92 Year 3These figures do notchange much ifthe quarter before thestabilization istaken as the starting point. 2

FIGURE 2 CHILEPRIVATE~ONSUhIfPTION 8.80- 8.75- 8.70- 8.65- 8.60- 8.55- 8.50- 8.45- 8.40 197 r 7 , I 197 , 8 1 I , 197 , 9 , I 198 , 0 1 1981 , Year FIGURE 3 ISRAELPRIVATEcONSUh4PTION 8.25 8.20 8.15 8.10 8.05 8.00 7.95 7.90 7.85 I I r , I I , I I , I , 1985 1986 1987 1988 1989 1990 1991 1992 3

Consumptionboomsfollowingstabilizationshavealsobeenobsemedin Denmarkin 1982 and in Irelandin 1987byGiavazziandPagano(1990). TheDanishexperienceda consumptionboom of 3.7VCandan investmentboomof 12.770during 1983-1987.InIreland,during 1987-1989,private consumptiong~w atan averagerateof 3.6~c,and investmentat6.7Y0. Severalexplanationshavebeenproposedintheliteratureforthemechanismthroughwhich stabilizationpoliciescouldgenerateconsumptionbooms. Themostprominentof theseistheidea . introducedby Calvo(1986)thata lackofcredibilityinthepmgm inducesthepublicto inc~ase currentconsumptionrelativeto futureconsumptionbecausetoday’seffectivepriceis lowerthanthe postcollapseprice. Anotherideaisthatthefall intheinflationrateatthebeginningof thepmgm generatesa wealtheffectbecausethevalueof governmentbonds(whicharepartof privatewealth) increases.@mno (1992)).JThisincreaseinthe valueofprivatewealthincreasesexpenditureand generatesa consumption boom. The thid explanation, which is thefocusof thispaper,isthat followinga stabilization,creditfromthebankingsystemtotheprivatesectorincreasesreducing liquidityconstraintsintheeconomy. A reductionin liquidityconstraintscangeneratea consumption -.--.....-‘.:...... boomthrougha declineinexcesssavingsor lumpypurcha..esofconsumerdurables. Theeffectsof allthreeoftheseexplanationsaremorepronouncedonconsumerdurablesthanon nondurable. In this paper,Iconcentrateon twoaspectsoftheroleofcreditin post-stabilization consumptionbooms. First,I showthatthereis a significantdropintheshareof householdsthatare liquidityconstrainedafterthestabilization.Previousstudies(Rossi(l988))haveshownthatliquidity constraintsare veryimportantinexplainingtheexcesssensitivityofconsumptioninLDC’S.Deaton (1989)showsthatconsumerswithbindingborrowingconstraintscanhavesavingsandasset accumulationin excessof whatisoptimalifthoseconstraintswe~ notbinding. Theresultsindicate thatthe~ wasa sharpreductionintheshareof liquidityconstrainedconsumersin bothMexicoand Chile,but thefall is notsignificantin Israel. 4 Forthis to hold.Ricardianrim-neutrality isrequired 4

A fallin theproportionof consumerswhoare liquidityconstrainedcan generatea consumptionboomintwoways. One isthrougha reductionin theexcesssavingsaccumulatedby thesehouseholds. A secondisthroughtheincreaseinpurchasesof consumerdurables. Allthe householdsthatprior to thestabilizationwere Liquidityconstrainedandcouldnotbuythedurables theywantedcando sowhen theyare no longerconstrained. Thisgeneratesabunching ofpurchases of consumerdurablesandajump intotalconsumptionexpenditures.s In the secondpartof thepaper, Ilookat thethreemainexogenouscharnels throughwhich bankingsectorcreditexpandedafterthestabilizationsandfueltheconsumptionboomsby reducing Liquidityconstraints. Prior to thestabilizations,thecombinationofasmall (andmostly)inefficient bankingsystemandahigh inflationenvironmentreflectedvery lowlevelsof bankcreditto theprivate sector. particularlyconsumptioncredit. Thedrasticfallinthe inflationrates afterthestabilizations combinedwithprogressivefinancialreformsworkedto increasetheresourcesavailableto thebanking sectorto financeprivateconsumption. The ratioofbankingcreditto totalprivateconsumptionwent from 29.8 percentin 1978t098.4 percentin 1982inChile. In Mexico,the ratioof consumercredit to totalprivateconsumptionwentfrom2.9 percentin 1987to 10percentin 1992.and inIsraelthe ratioof unlinkedbankcreditto totalprivateconsumptionwentfrom 15%in 1985to 30%in 1988.67 The resultshighlightthedifferencebetweenthefinancialsectorsin MexicoandChileonthe onehand. and Israelon theother. In Mexicoallthreechannelsfor theincreaseincreditto consumersare very important;thatistheremonetizationofthe economy,thefallin theratioofdebt heldby bankstoGDP, and theincreasein foreignliabilitiesheldby banks. For Chile, themost importantchannelistheremonetizationof theeconomy,whilefor Israelit is thefallin theratioof publicsectordebtheldby bankstoGDP. Israel’shighlyindexedfinancialsectorand itshighprivate 5Hayashi(1982) makesa simitar argument. 61nIsrael, unlinked Bankcredit isthe source of mostconsumer loans. 7 De Long and Summers (1987) also credit the increased availability of consumer loans with the reduced variability of aggregate demand and the fall in liquidityconstraints inthe postwar U.S. 5

explainwhytherewasnota significantincreaseinthevolumeof financialintermediationafterthe stabilization,whileforMexicoandChilethis was a ve~ importantfactor. Therestofthe paperis structuredas follows. Section11Elates themainfeaturesofthe stabilizationprogms andtheevolutionofcreditandconsumptionthereafter. Section111presentsthe permanentincomehypothesis(PIH)andsetsoutanalternativeal!owingfor liquidityconstrained consumers. Theempiricalinvestigationisctied outinSectionIVandSectionV concludes. II.A BRIEF HISTORY OF CHILE, MEXICO, ANDISRAEL Beforeturningto theestimationresults,wetakeabrieflookat thehisto~ ofthethree stabilizationepisodes. II.1 CHILE Followingthecoupof 1973,thegovernmentof Pinochetembarkedona programthatwould drasticallychangetheChileaneconomy. Between1973and 1975,thegovernmentstartedan ~gmssive progm to correctthemostimportantdistortionsofthepreviousregime. Duringthis ....-_ ......,-->-A L ..- - . ------ . period.a gradualanti-inflationarypolicywas implementedwithoutmuchsuccess. In Aprilof 1975, thefirstseriousattemptto lowerinflationwas madeby anorthodoxprogm oftightmoneygrowth. B}I1978.however,it hadbecomeclearthatthepmgrarnwasnotworkingandwithinflationstill runningat 37VCa yearthe governmentchangedcourseandstartedtargetingtheexchangerate. In 1979,thegovernmentintroduceda newstabilizationplanbyfixingtheexchangerateat 39 pesos perdollar. The programworkedwellfora whileandinflationfellto IOYoby 1981;however,the exchangeratebecameprogressivelyovervalued. Bylate 1981itbecameapparentthattheChilean “miracle”wascomingto anend. Thefourthquarterof 1981wascharacterimdbyextraordinarilyhigh realinterestrates,a hugecurrentaccountdeficit,risingunemployment,and a fallin Ral GDP. (Dombusch(1993)). Theprogm collapsedinearly 1982anda severefinancialcrisisdeveloped. Duringthistime,Ra.1totalprivateconsumptioninChilegmwatanaveragerateof 4.3%peryear. .. 6

,— As we willsee lateron, thisconsumptionboomwasfueledby the increaseinconsumercreditwhich relaxedliquidityconstraintsintheeconomy. In additionto thegoalsoftradeliberalizationand inflationreduction,thestabilizationplan also includedmeasuresto liberalizefinancialmarketsandease restrictionson credit. Edwardsand Cox Edwards(1991)describeChile’sfinancialmarketduringmostof the60’sand70’sas a textbook caseof financialrepression. Creditmarketswere underdevelopedandhighlydistorted;thedegreeof financialintermediationwasextremelylow, real interestrateswere negative,andreserve requirements wereextremelyhighat 100%in 1973andthen42% in 1979. Mostimportantly,creditwas rationed andallocatedusingarbitraryand inefficientcriteria. Table 1showstheratioof M2 to GDP, real interestrates, andcreditto theprivatesector. TABLE 1: CHILE: INDICATORS OF THE FINANCIAL SECTOR 1970-1981 YEAR RealCreditto the M2/GDP RealInterestRatea PrivateSector (%) %per year 1975=100 1970 63.2 8.8 1971 91.2 13.1 1972 93.2 13.6 1973 77.2 10.7 1974 88.2 5.4 1975 100.0 5.6 1976 136.8 5.9 1977 270.0 8.3 8.8 1978 444.3 10.4 18.9 1979 585.0 12.0 6.8 1980 817.2 13.2 5.9 1981 983.7 21.2 26.5 Source: Edwards and Cox Edwards (1991)andvar]ousIssuesof the Central BankofCh’llemonthlybulletln. a) The ex-post real rates were constructed as r=(l +i)/(1+x)-1 where iisthe annualized nominal rate on shortterm deposits, and x isthe actual annualized rate of inflation.

The numbersshowa very strikingincreaseinthevolumeof financialintermediation, measuredby the increasein M2/GDPratio, after 1979. Priorto 1979,creditto theprivatesector was smallbut increasingdueto a combinationof thefallintheinflationrate and somereformsto the capitalmarkets. However.between 1977and 1981therealvolumeof totalcredit totheprivatesector increasedby 264%! Anotherindicationof thedeclineincreditrationingcan alsobe seenin the percentagefall in thespreadbetweenthedepositandthelendingrate, andthe increaseinthecreditto consumptionratio showninTable2. Thiscreditexpansionledto a fall in liquidityconstraintswhich helpedto fiel the consumptionboomduringthisperiod. EdwardsandCox Edwards(1991)pointout thattherise in expenditure(consumptionandto a lesserextentinvestment)was largelyfinanced throughhigher creditfromthebankingsector. TABLE 2: CHILE YEAR CREDIT/CONSUMPTION SPREAD (%) %per year 1975 6.6 . --.. . s l. - -. _ ,..-,. .~..- % G -.: ” , . 1976 9.8 1977 22.7 38.5 1978 29.8 17.3 1979 42.7 12.1 1980 59.6 5.5 1981 71.3 10.1 1982 100.7 4.6 source Isvarious Issuesot the Central Bankot Chlie monthlybulletln. Credlt/Consumption Isthe ratio ot total real credit tothe private sector to total real private consumption. Spread isthedifference betweenthe real short term lendinganddeposit rate. 11.2MEXICO Followingthedebtcrisisof 1982,Mexicobegana processof adjustmentwiththeaimsof reducinginflation.lowerthebudgetdeficit,and liberalizetrade. In 1986.oilpricesplummeted leavingMexicowitha newcrisis. In responseto thisshock,therewasa realdepreciationof thepeso 8

whichfueledinflation. By 1987,however,theacuteexternalsectorcrisiswasamplifiedbytheseve~ problemofinflation,which~ached almost160%inthatyear. OnDecember151987,theDeLa Madridadministrationsetinmotiona stabilizationpackagecalledtheEconomicSolidarityPact(PSE) to Educe inflationandstreamlinetheeconomy. Theexchangeratewasfixedandusedasa nominal anchorforprices. Thepactmanagedto reduceinflationfrom 159%in 1987to 51.6%in 1988withouta recession;todayinflationisaround8Y0.InadditionMexicohasbeenexperiencingaconsumption boom. Between1989and 1992,consumptionexpenditurehasinc~asedsignificantlyandgrewfaster thanoutputaveragingabout5.8Y0peryear. Table3 showssomemajoreconomicindicatorsfor Mexico. TABLE 3: MEXICO: MACROECONOMIC INDICATORS RealRatesof Growthunlessothewise stated. YEAR GDP CONSUMER CONS/GDP PRIVATE PRIVATE PRICES (%) CONSUMPTION INVESTMENT 1986 -3.8 105.7 63.2 -2.6 -11.1 1987 1.9 159.2 62.0 -0.01 6.4 1988 1.2 51.7 62.4 1.8 10.2 1989 3.3 19.7 64.4 6.8 7.5 1990 4.4 29.9 65.4 6.1 13.3 1991 3.6 18.8 66.1 4.6 12.7 1992 2.6 11.9 68.2 5.9 20.4 Source:TheMexican&onorny 1993.BancodeMexico. Thisconsumptionboomhasbeenfueledbytheextraordinaryincreaseinthevolumeof financialintermediationandmalconsumercreditwhichhassignificantlyreducedtheproportionofthe populationthatisliquidityconstrained. Priorto 1988,thefinancialsectorofMexicowasseverelyunderdevelopedandrepressed. Quantitativerestrictionsto creditwe~ widesp~ad,andinterestrateswemhighly~gulated. Between 9

the 1950’sand 1980’s,controloverc~dit wasexercisedthroughthequantitativecontrolsonthe intermediariesbytheimpositionofvexyhighreserve~quirements,selectivec~dit quotas,and borrowinginterestratessetbytheBancodeMexico-inmanycasesuponinstructionsfmmthe ministryofFinance-andnotbycurrentmarketconditions.(Aspe(1993)). Thoroughfinancial~fonns we~ implementedalongwiththenewpact. Startinginthefall of 1988,interestrateswe~ allowedto varymo~ dueto m~ket conditions,and“c~ditquotas”to high prioritysectorswe~ eliminated.By 1989,theselectivecreditmechanismwasnolongerinplace, compulsory~serve mquimmentswereremoved,andnewfinancialinstrumentswerecreated. All thesereformswe~ furtherstrengthenedbythefullprivatizationofthebankingsystemwhichbeganin May 1990andwascompletedin 1992. Thecombinedeffectoftheexchangeratebasedstabilimtionandthefinancial~fonns was to increasetheamountofconsumptioncreditto theprivatesector,throughtheinc~aseinthevolume offinancialintermediation.Tables4 and5 showtherapidincreaseinc~dit andthevolume of financialintermediation(asmeasu~dbyM2/GDPandM4/GDP). TABLE 4: MEXICO: FINANCIAL INTERMEDIATION MEASURES nAR M2/GDP M4/GDP Financingto Pvt.Sector (%) (%) (%ofGDP) 1985 27.7 33.3 12 1986 32.2 41.2 11 1987 31.8 43.7 10 1988 22.4 34.4 10.5 1989 24.6 39.9 14.5 1990 26.6 43.2 18.0 1991 31.1 44.8 26.0 1992 31.9 45.8 33.0 10

.& TABLE 5: MEXICO CREDIT GIVENTO INDIVIDUALSBYCOMMERCIAL BANKS RealRateof Growth 90-91 91-92 Totalto fim”sand individuals 41.1 36.8 Totalto individuals 59.0 55.9 Creditto Indiv.by Type Consumption 67.5 49.9 CreditCards 51.6 30.1 DurableGoods 100.5 129.8 Housing 52.6 60.9 Note: Sources tor bothtable 4and 5are the AnnualReport ofthe Bancode Mexlco 1992andThe Mexican fionomy 1993 from the Bancode Mexico. Data forTable 5 does not includefinancing from non-bankingfinancial intermediaries. AstheseTablesclearlyindicate,thegrowthin realcredithasbeenspectacular,particularly creditfor consumption.durablegoods.andhousing. Creditto privateindividualsmore thandoubled in 1991and 1992. We willsee inthenextsectionhowthis increaseincreditledto a fallinliquidity constraintswhichfueledtheconsumptionboom. 11.3ISRAEL Followingthestockmarketcollapseof 1983,a balanceofpaymentscrisisdevelopedin Israel. A maxi-devaluationledto a step increasein the inflationrate. Afterseveraltries withthree “packagedeals”amongthegovernment,themajorunionorganization(theHistadrut),andthe associationof privateemployeesto lowerinflationthroughwageandpricefreezes, thegovernment introducedan exchangeratebasedstabilizationprograminJulyof 1985. The mainobjectivesof the planwere to reduceinflationand improvethebalanceofpayments. The programthatwasannouncedwasverytough:itplamed to reducethebudgetdeficitby at least5%of GNP. Thiswasachievedmostlythroughsharpcutsinsubsidiesand highertaxes. The sheqelwas initiallydevaluedby 19%andthenfixedat 1.5sheqelper dollarfor a time. Wagesand priceswere alloweda one-timeadjustmentandthenfrozenat levelsthatcauseda significantreduction 11

I 1 1 , in the realwageinthe initialmonthsof theprogram. (Brunoetal..(l99l)). Theplanwasextremelysuccessfulin reducingbothinflationandthebudgetdeficit. Inflationfellfrom 500%a year to approximately16-20%per yearoverthenextcoupleof years, and thegovernmentdeficitfellfroman averageof 15%of GNP inthepreviousdecadeto beingbalanced andevena slightsurplusin 1986. The successoftheprogramwasreflectedina rapidconsumption boom. Between1986and 1987totalprivateconsumptiongrewatan averageannualrateof over 11%. Thisboomeventuallydeflatedin late 1988asa recessionsetin. Table6 showssomemain economicindicatorsfor thisperiod. TABLE 6: ISRAEL MAIN ECONOMIC INDICATORS RealRateof Growthper year (%) YEAR GDP PrivateConsumption GrossDomestic Investment 81-85avg 2.9 4.4 0.1 85 3.9 0.5 -10.6 86 3.6 14.2 10.4 87 5.2 8.5 2.9 88 1.6 3.8 -1.9 89 1.3 0.0 -2.7 90 5.4 5.3 22.6 source: Bankot Israel AnnualReport various Issues. Theconsumptionboomwaspartlyfieled bythe increasein realcreditfromthebanking sectorto theprivatesector. Between1985and 1990thecredittoconsumptionratiodoubled.See Table7. However,unlikethe Mexicanor theChileancase, Israel’sfinancialsystemishighly indexed. A very largeproportionof thefinancialsystemare liquidassets,mainlyforeigncurrency denominatedaccounts,whichare linkedto theexchangerateor theCPI. Inaddition,abouthalfof the creditgivento theprivatesectorby banksis indexedcredit. The indexationof thefinancial systemactsto protectdepositorsfrom inflationanddevaluationrisk. ThismeansthatIsraeli’swere ableto obtaincreditprior to thestabilizationas wellas afterit. 12

TABLE 7 ISRAEL: INDICATORS OF THE FINANCIAL SECTOR YEAR Credit/ M3/GNP Realcreditto the Private RealInterestRate Consumption (%) Sectorb %per year (%) GrowthRate 85 15.2 32.2 0 26.4 86 31.1 48.3 17.5 31.2 87 25.2 62.2 26.2 88 30.3 29.0 32.1 18.9 89 32.5 27.3 17.8 10.0 90 34.09 26.5 26.3 4.4 Source: Various issues ot the Annual Report ot the Bankot Israel. (a)Onunlinked free credit. (bjFrom Commercial Banks One of themain regulationsintroducedwiththe stabilizationprogramprohibitedanynew (foreigncurrency indexed)residentdepositswithmaturitiesof lessthana year (PATAM). The disinflationalongwiththe newregulationon foreigncurrencydepositswas reflectedas an increasein therelativedemandfor unindexedshort-termassets,whoseshare intotalprivateassetsquadrupled duringtheperiod 1984-1987.SeeTable8. Thisreshufflingof thepublic’sassetportfoliofrom foreigncurrencydeposits(includedin M3)to shortterm sheqeldeposits(whichare in M2)meantthat in Israelthere wasnota markedincreaseinthevolumeof financialintermediationlikein Mexicoor Chile. Table7 showsthattheratioof M3to GNP remainedrelativelyconstantthroughouttheperiod. 13

i TABLE 8 ISRAEL: ASSETSOF THE PRIVATE SECTOR Percentof TotalAssets YEAR INDEXED UNINDEXED .--------- .------------ —----------------------- Savings& LongTerm ResidentDepositsa DemandDepositsh Deposits 85 36.7 32.1 22.4 86 37.5 26.5 28.7 87 38.9 24.5 28.5 88 59.9 27.0 31.5 89 43.2 22.4 31.1 N’()[Se~:lurceisthe Annual Report of the Bankof Israel. various issues (aj includes Patams andother resident deposits (b) Includes currency incirculation As we see, Israelisa casewhichisdifferentfromtheothertwocountries. First, the consumptionboomwasonlyshortlived(between 1986and 1987)afterwhicha recessionensued.See Table6. Second,the roleof creditinthisexpansionis notas markedinthedatasincedueto the indexednatureof thefinancialsystemIsraeliswereableto keeptheirmoneyathomeandtherefore were ableto get loansprior to thestabilization. Finally,theprocessof liberalizingthe financialsector beganvery lateanddid notbear on thesupplyofconsumercredit. The firstminor changeswere not doneuntil 1987andmore wasdonein 1990. Theseeffectswillbecomeevidentin theempirical resultspresentedbelow. Next, we set up themodelof the PIH withan allowancefor liquidityconstrainedconsumers to see ifthe share of consumerswhichare liquidityconstrainedfallsin thesecountriesfollowingthe stabilizations. III. THE PERMANENT INCOME HYPOTHESIS ANDLIQUIDITY CONSTRAINTS 1nthissectionwepresentthepermanentincomehypothesis(PIH)whenwe allowfor the presenceof liquidityconstraints. Thismodelwillallowmeto testwhetherliquidityconstraints actuallyfallafter thestabilizations. 14

111.1. The Theory FollowingHall(1978),the PIH canbe modeledfromthedecisionsof a representative consumer. The basicsetofassumptionsare thatconsumersi)canfreelyborrow and Iendatthesame rate of interestii)haverationalexpectationsiii)haveidentical-timeseparablepreferenceswitheithera quadraticor logarithmicinstantaneousutilityfunctionandiv)camot die indebt. Therepresentative consumermaximizes V(A,)=E,~:=, (1+3 )+ U( c,) u’ >0 U1l <0 (1) S.f.(1) A,+,=(1+r ) ( A, + W, -C, ) for t =I,...,T-l (2) A~>0 whereT is thelengthof timea person lives,C isconsumption.8 isthesubjectiverateof discount,W[ is laborincome,Alare assethcldings,r is theconstantrateof returnon assets, and Etisthe expectationconditionalon theinformationavailableat timet. The firstorder conditionnecessaryfor an optimumis E, U’(c’(+),=( 1 +5 ) Uf(c’,) (2) 1 +r This isthe Eulerequationwhichisusuallytestedinconsumptionmodels;itsaysthatmarginalutility todayisthe bestforecastof marginalutilitytomorrowup to a constantmultiple. If we assumer=6 andthat U(C[)isquadratic,a thenmarginalutilityis linearandwecan use the randomwalkresultfor consumptionwhichstatesthatE,(C,+l)=C,. This saysthat consumptiontodayistheoptimalforecastof consumptiontomorrow,whichimplies A C, =El (3) 8For example. the typical quadratic utility function isU(C,)= -(a-Ct)2. The results hold if U(C,)isclose to quadratic or the change inmarginal utility from one period tothe next issmall. 15

where&tis a rationalforecasterror andrepresentsthenewsinpermanentincome. So, thechangein consumptionis notforecastable;thatisno informationint-1 or beforecanhelpinpredictingfuture consumptiongrowth. In empiricaltestsof the PIH. however,Flavin(1981)andHayashi(1982)havefoundthat certainvariables(e.g currentdisposableincome,stockpricesetc..) haveenoughpredictivepowerto rejecttherandomwalkhypothesis.9 Thisexcesssensitivityof consumptionto anticipatedchangesin incomesuggestsan alternativehypothesis. FollowingCampbelland Mankiw(1989),I nestthePIH ina moregeneralmodelwhich allowsfor someliquidityconstrainedconsumers. In thismodel,there issomefractionk of income whichaccruesto individualswho consumetheircurrentincome(i.e. theyareliquidityconstrained), whilethe remainder(l-k) accruesto individualswhoconsumetheirpermanentincome. Total incomethen, isthesumofthetwogroups’respectiveincome;thatis Y,= Y,, + Yl[. WhereY,, is the incomeof the liquidityconstrainedconsumers,andYzlistheincomeof thegroup whichbehavesaccordingto thePIH. SincethefirstgroupreceivesLof totalincome,Yl~=LY1and Y2t=(l-A)Y,. Per capitaconsumptionin thefirstgroupisthen Cl,= Y,, = ~Yt,implyingthat A Cl, =A Y,,=k A Y, (4) A Cz,=( 1 - k ) E, . . Usingequation(4)thechangeintotalper capitaconsumptioncanbewrittenas Underthis alternativehypothesis,thechangeinconsumptionisa weightedaverageofthechangein current incomeandtheunforecastableinnovationinpermanentincome. Equation(S)reducesto the Hall(1978)PIH when1=0. 9Forother studies were excess sensitivity has been foundsee Hansen andSingleton(1982). 16

111.2 Consumption and the RA Interest Rate The “randomwalk”hypothesisfor consumptiondependson theassumptionthatthereal interestrate is constant. However,thecountriesinour sampleallexperiencedlargechangesinthe real interestrate. If we ignorethiseffect,variationof thereal interestratecanmakeconsumption appearexcessivelysensitiveto incomeeventhoughindividualsintertemporallyoptimizewithoutany borrowingconstraints.~/ The generalizationof theconsumer’sEulerequationto allowfor changesin thereal interest rate(in loglinear form) isu/ Aci =p * AAY,+(3r, + z, (6) where rlisthe real interestratecontemporaneouswithAC~,andEtmaybe correlatedwith r~,butis uncorrelatedwith laggedvariables. The coefficiente=(l-~)a wherecsisthe intertemporalelasticity of substitution. Equation(6)tellsus thathighex antereal interestratesshouldbe associatedwith rapidgrowthof consumption. IV. LIQUIDITY CONSTRAINTS, CREDIT EXPANSIONS,ANDSTABILIZATIONS 1nthis section,weuse theframeworkdevelopedintheprevioussectionto investigatethe effectsof creditexpansionsafterstabilizationson liquidityconstraints. First, I lookat whetherthere was a reductionin liquidityconstraintsafterthestabilizations,thenI examineifthere isa positive correlationbetweenincreasesincreditto theprivatesectorandprivateconsumption. Finally,I look at thechannelsthroughwhichcreditexpansionsoccurredin Mexico,Israel, andChile. ~/ SeeChristian (1987)on this point. U/ See. for example. Hansenand Singleton(1982),andHall(1988). Notethat intheprocessoflog-linearizing the first-order condition. the variance of consumptiongrowth has been includedintheconstant term. Hence, heteroskedasticity isonepossible reason for rejection of the model; see Barsky(1985)fora preliminary exploration ofthis issue.

IV.1 Stabilizationsand Liquidity Constraints Usingthemodelsetup in sectionIII, weestimateLdirectlyand testthehypothesisthat k=O againstthealternativethatconsumersare liquidityconstrained( 1 < L <0 ). Thisdirect estimationof k hastheadvantageof providinga usefulmeasureoftheeconomicimportanceof deviationsfromthetheory. For example,iftheestimateof Aiscloseto zerothenonecansay that thePIH isapproximatelytrueeven if k isstatisticallysignificant. Sincetheerror termmaybe correlatedwithAY,,weuseinstrumentalvariables,because leastsquaresestimationofequation(6) canproduceinconsistentestimates. Anylaggedstationary variablesare potentiallyvalidinst~ments sincetheyare orthogonalto Et. Theinst~ments usedwere selectedbecausetheyhelppredictincomegrowth.The instrumentsI usedare acombinationof the following;lagstwothroughfourof eachof thefollowingvariables,AC,,AY,,andthe followingper capitavariablesrealexports,realgovernmentexpenditure,realgovernmentconsumption,real investment,realMl, thetermsof trade anda trend.u/ -.-.-.-..-.... I estimatedequation(6) for Mexico,Chile,andIsraelunderthenullhypothesisthatk -.-:.:C.:. remainedconstantduringtheentiresampleperiod. Thealternativehypothesisisthatk fellafterthe stabilizationprogram. Themodelis a log-linearapproximationtothetrue modelin levelsand differencessinceaggregatetimeseries on consumptionandincomeseemto becloserto log-linear thanlinear. Thatis, themeanchangeandthe innovationvariancebothgrowwiththe levelof the series.U/ Dueto thefactthatconsumptionand incomearemeasuredas quarterlyaveragesratherthan pointsin time, thenmeasuredconsumptionis thetimeaverageof a randomwalkif thepermanent incomehypothesisholdsincontinuoustime. Therefore,thechangeinconsumptionwillhavea firstorder serial correlationof0.25, whichcouldleadus to rejectthemodeleven ifitis true. To ~/ Several combinationsoftheseinstrumentsweretried foreachcountry,theresultsdidnotvarymuchfromtheonesreported here. B/ See Campbell andDeaton (1989)on this. 18

eliminatethisproblem, the instrumentsI usedare laggedmore thanoneperiod, so thereis at leasta two-periodtimegap betweenthe instrumentsandthevariablesin equation(6). Thetimeaverageofa continuoustimerandomwalk isuncorrelatedwithallvariableslaggedmore thanoneperiod, so by usingtwice-laggedinstrumentswe obtaina testof themodelthatis validfor time-averageddata.~/ To estimatethemodelI useddatafromvarioussourcesincludingtheIFSanddataprovided bytheCentralBanksof Mexico,Chile,and Israel.~/ Thedataused are as follows:Y,isper capita realGDP. C~is totalreal privateconsumptionper capitaandr[isthe real interestratewhichwas constructedfromthe nominalex postdepositratefor Mexicoand Chile. and fromthelendingrate in Israel.~/ Thereare twodata issuesto dealwithhere. Thefirst, is thatfor thecountriesstudiedhere, relativelylongtimeseries of quarterlyconsumptiondataare onlyavailablefor totalprivatespending whichincludesdurables.~/ If weassumeexponentialdepreciation,however,durabilityshould merelyleadto thechangeinconsumerspendingbeinga first-ordermovingaverageprocessrather thanwhitenoise.~/ SinceI amusingtwice-laggedinstruments,the inclusionof spendingon durables doesnotchangethe implicationof thepermanentincomehypothesisthatforecastablechangesin incomeshouldnotleadto forecastablechangesinCortsut-nption.second, I use GDP as a proxy for disposablepersonalincome. This isnota perfectproxybutitshouldstillprovidea validtestof the nullhypothesisthatthepermanentincometheoryiscorrect. ~/ See Working (1960)on this. ~/ Iwouldlike to thank Gil Bufman, Leonardo Leiderman, Rati Melnick. Carmen Reinhart, RodrigoVergara, and Martin Werner for providing me the data used inthis paper. For Israel and Mexico C and Y are seasonally adjusted. M/ Theex-post real interest rate wascalculated as r=[(l +i)/(l+n)]-l. Where iistheannualized depositor lendi~grate, and n isthe annualized quarterly inflation rate. H/ Hayashi(1982)”makesthepointthata“measureofconsumptionwhichincludesexpenditures ondurables isamore relevant measure of consumption for liquidityconstrained consumers sincethey mustuse their saved incometopurchase durables. ~/ See Mankiw (1981) on this. “19

Thefinalequationestimatedforeaehcountry consisted of: whe~ D,is adummyvariableequalto Opriortothestabilizationand 1afterwards,DY~=AYt*Dt, andDr,= PD,. Thedummyvariablesaredefinedasfollows. 1) Mexico D =O 1980.1-1987.4 1 1988.1-1992.4 , 2)Chile D = O 1975.1-1978.4 1 1979.1-1983.1 3)Israel D = O 1980.1-1985.4 1 1986.1-1992.4 Table9 showstheresults. TSLSEstimates MEXICO CHILE ISRAEL --------------------------------------------------------------------------- 1980.1-1992.4 1975.1-1983.1 1980.1-1992.4 1. p. 0.0039(.99) -0.001(-0.02) 0.004(.45) 2*% 0.931(4.6)’ 0.863(1.72)’ 0.88(2.19)b 3. 00 0.042(1.8)C -0.03(-0.24) 0.003(.31) 4. p, 0.005(.97) -0.043(-0.7) -0.003(-.21) 5. k, -0.783(-2.63)’ -0.70(-1.00) -0.88(-1.49)’ 6. 0, -0.086(-2.56)’ -0.25(-0.92) 0.04(1.04) 7. N 47 32 48 8.AY,R* .09 .49 .0002 9.ArtR2 .79 .93 .5] F-Statistic 6.94 1.00 2.21 CriticalF (10%) 2.84 2.88 2.84 Note: t-stausocsarepresented Inparentheses. (a) Indicatessignificantatthe 1%level,(b)atthe5%level,and(c) atthe IWO level (d) atthe 15%level. TheF-Statisticswe~ dalated usingthecorrectedmethodsuggestedbyWooltidge (1991). Different-binatims oftheinstrumats gaveverysimilarresults. 20

The estimatesfor theproportionof thepopulationthatis liquidityconstrainedclearlyshowa decreaseafter the stabilizations. For Mexico,theestimateisO.93beforethestabilizationand0.15 after, withthedrop significantat the 1%level. For Chile,theestimateis0.86 before, andO.16afier. Finally,for Israel theestimateis0.88 beforeand0.0 after at the 15%level. An F-testshowsthatthe changein Lfor Mexicoissignificantat the5%level,for Chileissignificantat the 25% level,and for Israel it is significantatthe 5% level. Eventhoughfor bothChileandIsraelthedrop inLisnot significantat normallevels,thisispartlydueto thesmallnumberofdatapointsbeforethe stabilizationand inthecaseofChileafterthe stabilizationas well. For Chile, whenthe sampleis extendedto 1989themagnitudeof thecoefficientsdo notchangebutthedrop in 1 becomes significantat the 5%level. Rows8 and9 presentthefirst stageadjustedR2,whichare highrelative to thosefoundby Campbelland Mankiw(1989),indicatingthattheinstrumentsusedhavesignificant power inpredictingincomegrowthandthe interestrate. This impliesthatwe can rejectthe permanentincomehypothesisandthehypothesisthatLremainedconstantthroughoutthe samplewith a fair bitof confidence. The resultsof Table9 showthatliquidityconstraintsfelldrasticallyafter thestabilizations. inthenextsectionwe determinethatthiswasbroughtaboutby an increasein creditfromthebanking sector. IV.2 Consumption and Credit If in facttheexpansionof creditreducesliquidityconstraintsandcan thereforebe usedas an explanationfor the consumptionboomswe observe,thenthemodelpresentedin sectionIII isan approximation. In particular, ina completemodelof consumptionwithborrowingconstraintsthe fractionof consumersexhibitingexcesssensitivity(L)willdependona varietyof factorssuchas wealth,income, individualcharacteristics,and more importantly,onhowwellcreditmarketsfunction, 21

Table 10presentsthesamplecorrelationsbetweentotalper capitaprivateconsumptionandcreditto theprivatesectorfrom thebankingsystem. Thiscorrelationgivesus an indexby whichto measure howconsumptionand creditmovetogether. The correlationbetweenthetwo seriesisstrongestfor Mexico,butfor allthreecountriesit is fairlystrong. TABLE 10: CONSUMPTION AND CREDIT Country Correlation Mexico 0.93 Chile 0.60 Israel 0.85 Note: For Israel. credit Isunllnkedbankcredit to the nontlnanclal private sector, tor Mexico ItISconsumptioncredit tothe private sector. and for Chile it istotal claims on theprivate sector fromcommercial banksand other bankinginstitutions. In order to geta bettersenseof howconsumptionandcreditare related,wepresenta .,.- --.---,-,.-x; scatterplotofper capitaconsumptionandper capitacreditfor eachcountry. Figures4,5,and 6 show thatinallcasesconsumptionand creditare positivelyrelatedanda regressionlineofconsumptionon a constantandcreditshowsthatthisrelationshipfitsquitewell. 22

MEXICO FIGURE 4 FIGURE 5 ISRAEL 4000 + 47.5 l+ .’ + 45.0 3500 + + + * + 42.5 + +++ + + + 40.0 l+ + + +. ++++ 2500 + 37.5 l 2000 35.0 0 1000 2000 3000 4000 5000 6000 0.0 0.5 1.0 1.5 2.0 2.5 Per Ca~ta Credit Per Capita Credit L’HILE FIGURE 6 7000 + 6000 ++ ++ 4000 * 0 5000 10000 15000 20000 25000 Per Capita Credit 23

These correlations suggest that credit might be an important determinant of consumption if it Worksto reduce the share of households that are liquidity constrained in the economy.E/ The reduction in liquidity constraints can generate the consumption booms we observe because it allows consumers who desire to consume more. but could not due to borrowing constraints, to increase their consumption and to reduce their excess savings; or by allowing them to purchase the durables they have been waiting to buy. IV.3 Sources of Credit Expansions After Stabilizations The evidence presented in the previous section, shows that increases in credit after stabilizations play an important role in reducing credit constraints after these plans were enacted. In this section, I look at the exogenous sources of these credit expansions. There are three possible channels through which credit can increase after a stabilization. These channels are evident when looking at the following accounting identity ..,...-, ----:--<:from a bank balance sheet. private SectorLoans=Depositi- Resemes- Govt.hans (8) First, an increase in deposits given the level of public debt held by banks (and the level of reserves) increases the supply of loans to the private sector. The increase in deposits can come from the repatriation of capital held abroad as inflation stabilizes at lower levels and is reflected in the rapid remonetization of the economy as measured by an increase in M2/GDP. The second channel through which credit availability can increase after a stabilization is through a decline in the level of public debt held by banks at any given level of the ratio of ~/ If we assume that credit is exogenous.wecan write ~=~-~red, andpluggingthis intoequation(6) weget AC,=p+~AY,yAYt*cred,+ert+&,.This was estimated for all the three countries. and in each case y was negative and highly signilimt. The estimates were Y~C,K,,-=1.04,ych,l~-=1.4E-05.andY,.,~,l=-9.3E-05, indicatingthatanincreaseincredit reducesliquidityconstraints. 24

M2 to GDP. Resources from the financial sector which were previously being used to finance the government can now be used to finance the private sector. This crowding in effect of a lower level of public debt occurs independently of the increase in the volume of financial intermediation. Each of these channels in and of themselves, can explain the increase in availability of credit to consumption following a stabilization. This implies that any (or both) of these reasons could be the key to explaining the decline in liquidity constraints that occurs after stabilizations. In effect, the level of credit in the economy is negatively related to the level of public debt held by the banking sector (scaled by GDP), and positively related to the degree of remonetization, measured by M2/GDP. With these effects in mind, we specify the share of the population that is liquidity constrained endogenously. (9) where M2/GDP is the ratio of M2 to GDP and B/GDP is the ratio of the real stock of internal public debt held by banks to GDP.u/ We expect yto be negative and ~ to be positive. Equation (9) says that as the economy gets remonetized credit increases so liquidity constraints decrease, and that as the level of debt increases the amount of credit decreases so 1 increases. Substituting equation (9) into (6) we get (lo) ~/ Bisthesum oftheIFS1ines52an,52b,and 52cforMexico,thesumof 22a-c,42a-c,and42apfor Chile,anditisline 22a forIsrael. Theresul~ are approximatelythesamewhenthebudgetdeficitwasusedinsteadofthestockofpublicdebt. 25

‘1 where M2Y[=M2/GDP * AY~and BY,= B/GDP * AYI. I estimated equation (14) for Mexico Chile. and Israel. ~/ The results are shown in Table 11. For Mexico and Chile, it is clear that the remonetization of the economy after the stabilization was a key element in the credit expansion (and therefore in the reduction in liquidity constraints) that ensued. As expected, we see that the estimate of Yis negative and significant at the 10YOlevel. On the other hand, this is not the case for Israel. ‘I’his is not Surprising, since as we mentioned before, the financial system of Israel is very different from that of either Mexico or Chile. Its highly indexed system acts to protect depositors from inflation and devaluation risk; therefore the level of banking resources available to the private sector did not change much from before the stabilization to after it. The steadying of the exchange rate and consequent sharp drop in devaluation expectations, the drop in inflation, and the rise in real interest rates on local currency accounts led to a drastic change in financial asset holdings, notably a shift from PATAM and other resident deposits to short-term sheqel deposits. In -:~.. ..-..:- ... -~-: a Israel, people kept the money at home but they kept it in accounts linked to the dollar, when the stabilization lowered inflation, people switched from dollars to domestic currency but the amount of resources in the banking system did not change much. This is reaffirmed by the evolution of the volume of financial intermediation as measured by M3/GNP shown in Table 7. ~/ The methodof estimatim isalwaysTSM withthesame setof instrumentsasbefore. 26

TSLS MEXICO CHILE ISRAEL ------------------------------------------------------------------------------- Estimates. 1983.1 1992.4 1975.1 1989.4 1980.1 1992.4 v 0.003 (1.0) -0.007 (-.34) 0.009 (1.40) P 0.61 (2.06)b 2.80 (2.49)” 0.17 (.23) Y -3.06 (-1.73)’ -2.24(-1.63)’ -0.92(-.57) 8 2.33 (1.98)b 0.89 (.10) 0.36 (1.35)’ 6 0.02 (.65) -0.05 (-.64) -0.008 (-.75) N 40 60 48 Note: The sample period for Mexico begins in 1984.1 since data on the public stock of debt are not available earlier. t-statistics are presented in parentheses. (a)indicates significant at the 1% level, (b) indicates significant at the 570 Ie\el. and (c) at the IOYOlevel. and (d) at the 15% level. Looking at the results for the estimate of ~ we see that it is positive (as expected) in all cases, but it is only significant in Mexico and Israel. This implies that for Mexico the channels through which credit expansions occurred were both a remonetization of the economy and the fall in public debt held by the banking sector. The crowding in effects from a fall in public debt held by the banking system are ulso quite important in Israel. This is logical since one of the principal objectives of the stabilization plan was to drastically reduce the deficit to GDP ratio. Even though this was the case in Chile as well, the data for Chile are very bad and some of the missing years were interpolated from the existing series. ~/ In addition to the two channels through which credit expansions can take place already mentioned, there is a third factor. Banks can issue liabilities abroad and use these 27/ Itied ~nm.]inear swcification forLinordertoensurethatit isalwaysbetweenOand 1sincethe linear specificationhas a theproblemthatLcan become negativeas M2/ GDP gets large. or larger than one as BIGDP gets too large. I specified L as L=l/exp’h’zGDp]’-5[1/exp(BKDpa)]nd estimated AC,=p+yAy,*[1/exp‘MUGDP)]-3AYl,/*e[xp(BfiDp)]+er,+e,T.heresultsare thesame foreachcountry. 27

resources to increase the amount of loans to the private sector. In order to take this effect into account we respecified 1 as (11) where FL are the real short-term foreign liabilities of the banking sector. Substituting equation (11) into equation (6) we get AC,~ +~AY,+yM2Y,+5BY,+pFLY @ , r, W, (12) where FLYt= FL/GDP * AY1. We expect y and p to be negative and 6 to be positive. The results are presented in Table 12. TABLE 12: AC,=p + ~AYl+ YM2YI+ ~BY, + pFLY[+er, + 8, TSLS Estimate MEXICO CHILE ISRAEL ______________________________________________________________________ 1984.1 1992.4 1975.1 1992.4 1981.3 1992.4 P 0.004 (1.36) -0.004 (-.16) 0.006 (.63) P 1.26 (2.79)’ 2.4 (1.78)C 4.35 (1.0) Y -2.02 (-1.37) -3.54 (-1.61)C -5.24 (-.89) 6 1.57 (1.40)d 2.54 (.25) 1.81 (1.34)~ P -59.1 (-1.78)’ 6.48 (.82) -4.17“(-1.24) e 0.002 (.40) -0.08 (-.82) 0.004 (.28) N 36 60 46 ~Otc:TheSamp\eperiodfor Mexico begins in 1984.1 since data on the public stock of debt are not available earlier. t-statistics are presented in parentheses. (a)indicates significant at the 1% level, (b) indicates significant at the 5V~ level, and (c) at the 107olevel, and (d) at the 15% level. The results show that only for Mexico does the increase in foreign liabilities by the banking sector make a difference in the increase in credit and consumption. It also makes the remonetization not as important (y is significant at the 2070level). For Chile and Israel this 28

channel does not seem to matter and as before the relevant channels are the remonetization and the fall in the public debt held by banks respectively. V. CONCLUSIONS In looking at the role of credit in the post-stabilization consumption booms of Mexico, Chile, and Israel, we find that the expansions in banking credit after the stabilizations are indeed an important determinant of consumption. The paper shows that there is strong evidence against the PIH and that liquidity constraints were quite important in these countries prior to the stabilization. In addition, we see that the share of households that are liquidity constrained falls sharply after the stabilizations. This effect is strongest in the case of Mexico. The decline in liquidity constraints can generate a decline in excess savings and/or a lumping of expenditures on consumer durables which can help explain the consumption booms that we observe. In looking at the sources of credit to consumers in these economies, I find that for the case of Mexico, all three of the sources examined played an important role. Credit to consumers expanded through the remonetization of the economy, through the decrease in the ratio of debt held by banks to GDP, and through the increase in foreign borrowing by banks. For Chile, I find that only the remonetization matters; and for Israel only the crowding in effect matters. These results highlight the difference in the financial markets of Mexico and Chile on the one hand, and Israel on the other. Israel’shighly indexed and developed financial system mean that there was not a significant increase in the volume of financial intermediation after the stabilization since it was already fairly high. Consumers in Israel had access to domestic indexed credit prior to the stabilization whereas in Mexico and Chile this was not the case. This means that the impact of the increase in credit in Mexico and Chile is 29

much larger than in Israel. These results suggest that the role of the financial system in the economy is quite important when monitoring the progress ofan economy after a stabilization. A country considering an exchange rate based stabilization should be very vigilant of developments in the financial sector. More importantly, to avoid a boom-and-bust cycle and the possibility of banking crises, countries should keep their financial systems tightly monitored and regulated, particularly during the expansionary phase. . . 30

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InternationalFinanceDiscussionPapers IFDP Number Titles Author(s] 1996 569 TheRoleof CreditinPost-Stabilization MartinaCopelman ConsumptionBooms 568 HazardsinImplementinga MonetaryConditions KariH. Eika Index NeilR.Ericsson RagnarNymoen 567 FinancialInnovationAndTheSpeedof Adjustment MartinaCopelman of MoneyDemand: EvidenceFromBolivia, Israel,AndVenezuela 566 Long-TermEvidenceontheTobinandFisher ShaghilAhmed Effects: ANewApproach JohnH. Rogers 565 Some,EvidenceontheEfficacyoftheUKInflation ChanHuh TargetingRegime: AnOut-of-SampleForecast Approach 564 TheUseof theParallelMarketRateasa Guide NitaGhei to SettingtheOfficialExchangeRate StevenB.Kamin 563 CountryFundDiscountsandtheMexicanCrisisof JeffreyA. Frankel December1994: DidLocalResidentsTurn SergioL. Schmukler PessimisticBeforeInternationalInvestors? 562 EasternEuropeanExportPerformanceduring NathanSheets theTransition SimonaBoata 561 Inflation-AdjustedPotentialOutput JaneT. Haltmaier 560 TheManagementof FinancialRisksatGerman AllenB.Frankel NonfinancialFirms: TheCaseof Metallgesellschafi DavidE.Palmer 559 BroadMoneyDemandandFinancialLiberalization NeilR.Ericsson inGreece SunilSharma 558 StockholdingBehaviorofU.S.Households:Evidence CarolC.Bertaut fromthe 1983-89Surveyof ConsumerFinances Pleaseaddressrequestsfor copiesto InternationalFinanceDiscussionPapers,Divisionof InternationalFinance,Stop24,Boardof GovernorsoftheFederalReserveSystem, Washington,DC 20551. Email: graym@frb.gov.Fax: (202)736-5638. 33

InternationalFinanceDiscussionPapers. IFDP Number Titles Author(s\ 1996 557 Firm SizeandtheImpactofProtlt-MarginUncertainty VivekGhosal on Investment: DoFinancingConstraintsPlayaRole? PrakashLoungani 556 RegulationandtheCostof CapitalinJapan: A Case JohnAmmer Study MichaelS. Gibson 555 TheSovereigntyOption: TheQuebecReferendumand MichaelP. Leahy MarketViewsontheCanadianDollar CharlesP. Thomas 554 RealExchangeRatesandInflationinExchange-Rate StevenB.Kamin BasedStabilizations:AnEmpiricalExamination 553 MacroeconomicStateVariablesasDeterminants JohnAmmer of AssetPriceCovariances 552 TheTequilaEffect: TheoryandEvidencefrom MartinUribe Argentina 551 TheAccumulationof HumanCapital: Alternative MuratF. Iyigun ............... MethodsandWhyTheyMatter AnnL.Owen 550 AlternativesinHumanCapitalAccumulation: MuratF. Iyigun Implicationsfor EconomicGrowth AnnL.Owen 549 MoreEvidenceontheLinkbetweenBank MichaelS. Gibson HealthandInvestmentinJapan 548 TheSyndromeofExchange-Rate-Based EnriqueG. Mendoza StabilizationandtheUncertainDurationof MartinUribe CurrencyPegs 547 GermanUnification: WhatHaveWeLearned JosephE. Gagnon fromMulti-CountryModels? - PaulR.Masson WarwickJ. McKibbin 546 Returnsto ScaleinU.S.Production:Estimates SusantoBasu andImplications JohnG. Fernald 545 Mexico’sBalance-of-PaymentsCrisis: A Chronicle GuillermoA. Calvo of DeathForetold EnriqueG. Mendoza 34

InternationalFinanceDiscussionPapers IFDP Number Titles Author(s) 1996 544 TheTwinCrises: TheCausesof Bankingand GracielaL. Kaminsky Balance-of-PaymentsProblems CarmenM.Reinhart 543 HighRealInterestRatesintheAfiermathof GracielaL. Kaminsky Disinflation:Is ita Lackof Credibility? LeonardoLeiderman 542 PrecautionaryPortfolioBehaviorfroma Life-Cycle CarolC.Bertaut Perspective MichaelHaliassos 541 UsingOptionsPricesto InferPDF’sforAssetPrices: WilliamR.Melick AnApplicationto OilPricesDuringtheGulfCrisis CharlesP. Thomas 540 MonetaryPolicyintheEnd-Gameto Exchange-Rate StevenB.Kamin BasedStabilizations:TheCaseof Mexico JohnH. Rogers 539 ComparingtheWelfareCostsandtheInitialDynamics MartinUribe ofAlternativeTemporaryStabilizationPolicies 538 LongMemoryinInflationExpectations:Evidence JosephE.Gagnon fromInternationalFinancialMarkets 537 UsingMeasuresof Expectationsto Identi&the AlIanD.Brunner Effectsof a MonetaryPolicyShock 536 RegimeSwitchingintheDynamicRelationship ChanHuh betweentheFederalFundsRateandInnovationsin NonborrowedReserves 535 TheRisksandImplicationsof ExternalFinancial EdwinM.Truman Shocks: LessonsfromMexico 534 CurrencyCrashesinEmergingMarkets: An JeffreyA. Frankel EmpiricalTreatment AndrewK. Rose 533 RegionalPatternsintheLawof OnePrice: The CharlesEngel Rolesof GeographyVs.Currencies JohnH. Rogers 35