Contagion, Bank Lending Spreads, and Output Fluctuations

A positive historical shock to external spreads can lead to an increase in domestic spreads and a reduction in the cyclical component of output. Shocks to external spreads immediately after the Mexican peso crisis had a sizable effect on movements in output and domestic interest rate spreads in Argentina. Agénor, Aizenman, and Hoffmaister study how contagion affects bank lending spreads and fluctuations in output in Argentina. They analyze what determines bank lending spreads when verification and enforcement costs for loan contracts are high. They present estimates of a vector autoregression model that relates bank lending spreads, the cyclical component of output, the real bank lending rate, and the spread in external interest rates. Using generalized impulse response functions, they show that a positive historical shock to external spreads leads to an increase in domestic spreads and a reduction in the cyclical component of output. Historical decompositions indicate that shocks to external spreads immediately after the Mexican peso crisis had a sizable effect on movements in output and domestic interest rate spreads in Argentina. This paper - a product of Economic Policy and Poverty Reduction, World Bank Institute - is part of a larger effort in the institute to analyze the real effects of financial sector inefficiencies