On the Role of the Collateral Constraint Friction in the North-South Transmission of the 2008-2009 Financial Crisis

This paper assesses the role of a popular collateral constraint-based transmission mechanism in the North-South transmission of the 2008-2009 financial crisis. Theoretically, in the presence of collateral constraints, depressed asset prices caused by a negative shock in a large creditor country generate feedback cycles in a smaller debtor country, in which the decline in borrowing capacity and the collapses of investment and output reinforce each other. I find that although the mechanism has appealing qualitative features and is consistent with the data, quantitative results from the model can only account for a very small part of the actual output declines.