Systemic Sudden Stops: The Relevance Of Balance-Sheet Effects And Financial Integration

Abstract

Using a sample of 110 developed and developing countries for the period 1990-2004 we analyze the empirical characteristics of systemic sudden stops (3S) in capital flows --understood as large and largely unexpected capital account contractions that occur in periods of systemic turmoil --and the relevance of balance sheet effects in the likelihood of their materialization. We conjecture that large real exchange rate (RER) fluctuations come hand in hand with 3S. A small supply of tradable goods relative to their domestic absorption --a proxy for potential changes in the real exchange rate --and large foreign-exchange denominated debts towards the domestic banking system, denoted Domestic Liability Dollarization, DLD, are claimed to be key determinants of the probability of 3S, conforming a balance-sheet effect that impacts on the probability of 3S in non-linear fashion. Regarding financial integration, the larger is the latter, the larger is likely to be the probability of Sudden Stop; however, beyond a critical point the relationship gets a sign reversion.

Optimal exchange-rate policy under collateral constraints and wage rigidity

“…The frequency for EMs is similar to the frequency in Argentina during this period, and to other empirical estimates, such asCalvo et al (2008).…”

“…Moreover, the empirical literature suggests that both sides of the debate are supported by evidence. Cross-country regressions for EMs tend to show both that fixing the exchange rate during financial crisis episodes is associated with larger output contractions (see, for example, Ortiz et al, 2009), and that currency mismatch plays a key role in determining the access to international credit markets (see, for example, Calvo, Izquierdo, and Mejia, 2008).…”

The sudden stops of debt‐led capital inflows, credit crunch, and exchange rate regimes

“…Real outputmay grow in the short run if net exports rise in response to a currency depreciation, but investment recovery remains sluggish. Other researchers also reach a similar conclusion that a sudden stop would lead to output losses, accompanied in particular by a currency crisis as well as a sharp increase in current account deficits (Bordo et al, 2010;Calvo, 1998;Calvo et al, 2004Calvo et al, , 2008Cavallo & Frankel, 2008;Guidotti et al, 2004;Ortiz et al, 2012;). However, most empirical studies fail to further analyze the distinct effects of sudden stops due to different types of capital inflows.…”

Global drivers of gross and net capital flows

“…6 The sample covers 81 percent of global external assets and liabilities and 74 percent of world GDP in 1996. 7 It contains all the major industrialized countries, a broad set of emerging markets that includes all the major ones such as China, Russia and India, as well as the countries that experienced the largest capital ‡ow reversals during the global …nancial crisis, such as Iceland and the Baltic states. We do not include many small developing countries as these economies tend to be relatively …nancially closed and would 6 The latter include a couple of developing countries.…”

“…But since most of these countries are emerging markets, we will refer to them that way. 7 Here we exclude from the world total the countries or territories classi…ed by the IMF sta¤ as o¤shore …nancial centers: Andorra, Anguilla, Aruba, the Bahamas, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Cyprus, Gibraltar, Guernsey, Isle of Man, Jersey, Liechtenstein, Macao, Malaysia, Monaco, Montserrat, Netherlands Antilles, Palau, Panama, Samoa, Seychelles, Turks and Caicos Islands, Vanuatu.…”