Seminario CEDE - Victoria Nuguer

Emerging economies (EMEs) exhibit high regulatory barriers to firm entry, where the latter are associated with reduced access to credit markets. Reforms that reduce firm-creation costs have therefore become a key policy priority. At the same time, access to domestic credit markets can expose EME firms to external financial shocks that propagate to EMEs via the banking system, such as those experienced during the Global Financial Crisis. We present new VAR evidence showing that in response to adverse shocks to the US banking system, EMEs with low firm-creation costs exhibit smaller contractions and earlier recoveries in cross-border bank flows, domestic bank credit, and GDP compared to EMEs with high firm-creation costs. A two-country model with banking frictions, cross-border bank flows, and endogenous firm entry can successfully explain this evidence, and suggests that greater EME firm participation in domestic credit markets need not lead to greater macro and financial volatility.