Erwan Quintin

Felipe Meza

English

Research Papers in Economics

The behavior of productivity during
crises presents a difficult challenge for
standard macroeconomic models. Most
obviously, because the productivity of
labor falls so drastically, employment and
hours worked should fall much more than
the data show. So, therefore, should out-
put. In this sense, the most puzzling as-
pect of financial crises may not be that
factor productivity (the ratio of output to
input use) falls precipitously during
financial crises. In fact, total factor pro-
ductivity accounts for most of the behav-
ior of output during crises. Countries that
experience crises suddenly become less
productive, and the size of the drop is
far outside the typical range of produc-
tivity movements.
Beyond the Border
inancial crises punctuate the his-
tory of many developing nations
with devastating effects on eco-
nomic activity and standards of
living. In Mexico, for instance, a deep
peso devaluation in 1982 and the conse-
quent financial disruptions brought two
decades of miraculous growth to a sud-
den halt. Several episodes followed
throughout Latin America, causing much
of the area to experience a lost decade
of economic stagnation. Mexico’s deep-
est crisis struck in December 1994, when
yet another peso devaluation triggered
the country’s worst recession since the
Great Depression. 
Partly in hopes of reducing the fre-
quency of such crises, most researchers
have focused their attention on what trig-
gers a financial collapse. Among other
results, the study of past episodes under-
scores the importance of a credible com-
mitment to monetary and fiscal disci-
pline. Mexican authorities have made
remarkable, well-documented progress
in this area since the 1994 Tequila Crisis.
As a result, the premium the country must
pay on its debt issues is now among the
lowest in Latin America, and Mexico has
been crisis-free for over a decade. 
While our understanding of what trig-
gers crises has improved, the precipitous
fall of output that follows most episodes
continues to puzzle economists. Qualita-
tively, it is not surprising that financial
turmoil causes economic activity to slow.
Trade and investment credit play key
roles in market economies, and negative
shocks to the availability and cost of
finance are bound to reduce output. 
But during crises, output falls much
more than what the available data on the
use of productive factors would lead one
to expect. In the case of Mexico’s
Tequila episode, for instance, gross
domestic product fell much more than
hours worked and measures of the stock
of physical capital (Chart 1).
1 In the lan-
guage of neoclassical economists, total
F
Financial Crises: Still a Mystery
Mexico’s Tequila Crisis
Chart 1
NOTES: All figures are in yearly, per capita terms. Total factor productivity is the ratio of GDP to an index of input use. The vertical bar marks
the onset of the crisis.
SOURCES: Instituto Nacional de Estadística, Geografía e Informática (INEGI); International Financial Statistics (IFS); authors’ calculations.
GDP
Index, 1994 = 1
.9
.95
1
1.05
1.1
2000 1995 1990
Hours Worked
Index, 1994 = 1
.9
.95
1
1.05
1.1
2000 1995 1990
Stock of Physical Capital
Index, 1994 = 1
.9
.95
1
1.05
1.1
2000 1990 1995
Total Factor Productivity
Index, 1994 = 1
.9
.95
1
1.05
1.1
2000 1995 1990
FEDERAL RESERVE BANK OF DALLAS   SOUTHWEST ECONOMY   SEPTEMBER/OCTOBER 2005 14output falls so much, but rather that it falls
too little.
Because productivity plays a domi-
nant role during turbulent times, a first
step toward understanding the real
impact of crises is to explain why they
cause the average productivity of factors
to fall so much. Among many possible
explanations, productive resources tend
to be used less intensively during turbu-
lent times. High interest rates combined
with low productivity give firms strong
incentives to postpone the consumption
of capital services (for instance, by leav-
ing plants or machines temporarily idle)
and economize on variable expendi-
tures, such as wear and tear, until busi-
ness conditions improve. On the labor
side, firms may choose to hoard workers
during periods of low activity to econo-
mize on labor-adjustment costs. Some
recent investigations find that capital uti-
lization and labor hoarding can, in fact,
account for a nontrivial part of produc-
tivity movements during crises. 
Promising as these findings may be,
however, factor utilization is not likely to
fully explain the real impact of crises.
First, productivity continues to fall by an
unusual amount after controlling for
changes in factor utilization. Second,
some calculations suggest that models
with factor utilization also predict that
output should fall much more during
crises than what we observe.
2 The
demand for factors is more stable in
those models than in models with fixed
utilization, but this is offset by large
swings in utilization rates. 
Given the difficulties crises pose for
standard models, understanding the real
impact of financial crises is likely to
require some modeling of resource allo-
cation across sectors. For example,
employment started growing briskly in
Mexico’s export sector after the 1994
devaluation. The fall in productivity
could reflect transitory losses in the qual-
ity of labor as employees devote time to
learning new skills. This line of research
should shed much-needed light on the
real effects of crises and could yield new
explanations for two decades of lacklus-
ter growth in Latin America.
—Felipe Meza 
Erwan Quintin
Meza is an assistant professor at the Uni-
versidad Carlos III de Madrid. Quintin is
a senior economist in the Research
Department of the Federal Reserve Bank
of Dallas.
Notes
1 For similar evidence of other crisis episodes, as well as a survey of the
recent literature on financial crises, see “Financial Crises and Total
Factor Productivity,” by Felipe Meza and Erwan Quintin, Center for
Latin American Economics Working Paper No. 0105, March 22, 2005
(www.dallasfed.org/latin/papers/2005/lawp0501.pdf).
2 See Meza and Quintin (2005).
Mexican GDP Falls but No One Notices
T
wo years ago, we reported on 
these pages about difficulty in 
correctly interpreting Mexico’s
GDP reports.
1 The complication involves
Easter’s habit of moving around in the
Gregorian calendar. Sometimes this reli-
gious holiday occurs in the first quarter
and sometimes in the second. Because
economic activity is reduced in the quar-
ter in which Easter falls, when Easter
switches quarters from one year to the
next, the situation is ripe for the confu-
sion we pointed out earlier. 
Easter fell in the second quarter in
both 2003 and 2004, so last year the issue
was moot. This year, Easter fell in the
first quarter, leading to possible confu-
sion.
In the opening sentence of its statis-
tical release on Mexico’s second quarter
2005 gross domestic product, the Insti-
tuto Nacional de Estadística, Geografía e
Informática (INEGI, Mexico’s census
bureau) reports that GDP was 3.1 per-
cent greater than in the second quarter of
2004. This statistic is calculated from data
that have not been seasonally adjusted
and, in particular, have not been
adjusted for Easter’s wayward effects.
The report further notes that GDP
declined 0.42 percent in second quarter
2005 relative to first quarter 2005.
The year-over-year statistic is what
the Mexican report has historically head-
lined—and with good reason. Until
fairly recently, INEGI did not calculate,
or at least did not report, seasonally
adjusted statistics. When analyzing data
that are not seasonally adjusted but are
subject to seasonality, it is standard
operating procedure to look at year-
over-year changes. When seasonal ef-
fects are irregular with respect to the cal-
endar, such as Easter’s, the year-over-
year calculation is not valid when Easter
falls in different quarters in successive
years. In other words, INEGI’s lead sta-
tistic sometimes suffers from statistical
bias.
INEGI’s seasonal adjustment proce-
dure is sophisticated, taking full account
of the Easter effect. The seasonally
adjusted data have been purged of the
potentially distorting effect of Easter
moving around in the calendar. This
makes it possible to report meaningful
quarter-over-quarter statistics, which
INEGI does—but does not emphasize.
Although the main reason for emphasiz-
ing year-over-year changes has been
eliminated with INEGI’s now more
sophisticated approach to seasonal
adjustment, it may still be useful to cal-
culate such changes. But to be mean-
ingful, these changes must be calculated
from the seasonally adjusted data.
According to INEGI’s own seasonally
adjusted data, Mexico’s GDP grew 1.9
percent from second quarter 2004 to
second quarter 2005. INEGI’s reported
figure of 3.1 percent is biased upward
because Easter’s occurrence in second
quarter 2004 depressed that period’s
output.
In spite of the stumbling block
placed before them, analysts are often
able to make sense of the situation.
However, their reportage is often awk-
15 FEDERAL RESERVE BANK OF DALLAS   SOUTHWEST ECONOMY   SEPTEMBER/OCTOBER 2005

Financial crises: still a mystery

http://dallasfed.org/assets/documents/research/swe/2005/swe0505c.pdf

Financial crises: still a mystery

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