Real Effects of the Subprime Mortgage Crisis: Is it a Demand or a Finance Shock?

Author/Editor: Tong, Hui ; Wei, Shang-Jin
Publication Date: July 01, 2008
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
Summary: We develop a methodology to study how the subprime crisis spills over to the real economy. Does it manifest itself primarily through reducing consumer demand or through tightening liquidity constraint on non-financial firms? Since most non-financial firms have much larger cash holding than before, they appear unlikely to face significant liquidity constraint. We propose a methodology to estimate these two channels of spillovers. We first propose an index of a firm's sensitivity to consumer demand, based on its response to the 9/11 shock in 2001. We then construct a separate firm-level index on financial constraint based on Whited and Wu (2006). We find that both channels are at work, but a tightened liquidity squeeze is economically more important than a reduced consumer spending in explaining cross firm differences in stock price declines.
Series: Working Paper No. 08/186
Subject(s): United States | Consumer credit | Borrowing | Demand | External shocks | Liquidity controls | Financial crisis | Spillovers | Stock prices

Author's Keyword(s): liquidity constraint | demand contraction
Publication Date: July 01, 2008
Format: Paper
Stock No: WPIEA2008186 Pages: 37
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