BANKS AND MACROECONOMIC DISTURBANCES UNDER PREDETERMINED EXCHANGE-RATES

As the recent Mexican crisis vividly illustrates, Latin American count ries often go through boom-bust cycles caused by both domestic policie s and external shocks. Such cycles are typically magnified by weak ban king systems which intermediate large capital inflows. This paper deve lops a simple optimizing model to analyze how the banking sector affec ts the propagation of shocks. In particular, we show how the world bus iness cycle and shocks to the banking system affect output and employm ent through fluctuations in bank credit, We also analyze the countercy clical use of reserve requirements. Econometric evidence for Chile and Mexico supports the main predictions of the model.