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Output Costs of Currency and Balance of Payments Crises in Emerging Markets

Output Costs of Currency and Balance of Payments Crises in Emerging Markets. By: Hutchison, and Noy Presented By: John N. Denker. Overview. Investigated balance of payments and currency crises in 24 emerging market economies Panel Data between 1975 – 1997

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Output Costs of Currency and Balance of Payments Crises in Emerging Markets

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  1. Output Costs of Currency and Balance of Payments Crises in Emerging Markets By: Hutchison, and Noy Presented By: John N. Denker

  2. Overview • Investigated balance of payments and currency crises in 24 emerging market economies • Panel Data between 1975 – 1997 • BoP and Currency Crises are found to have dropped output by 5 – 8% over a two – three year period • Output recovers after three years post crisis

  3. Introduction • Frequency: 51 crisis episodes over the past 25 years, 8% of the time an emerging market was facing serious turbulence in currency markets

  4. Opposing Views on the likely output effect of a BoP and Currency Crises • 1. Traditional • With wage and price rigidities, a sharp nominal devaluation would produce a real depreciation in the short run, increase exports and stimulate employment and output

  5. Opposing Views on the likely output effect of a BoP and Currency Crises • 2. Alternate • A sharp devaluation would lead to limited importing of capital goods, through such channels as a wealth effect on aggregate demand, higher production costs, disruption in credit markets,or a sudden cessation in capital inflows

  6. Estimating the Effects of Currency and BoP Crises on Real Output Growth • Equation to estimate these effects are of the evolution of output in emerging markets • Determinants of output in this model are a set of domestic policy and external factors as well as country-specific fixed effects and lagged output growth • All variables, except openness have a one year lag to capture delayed response of output Macroeconomic developments

  7. Domestic Policy • Factors of Domestic Policy • Changes in Governmental Budgets • Credit Growth

  8. External Factors • Factors include • Growth in Foreign output • Real Exchange rate overvaluation

  9. Data Description • Defining Currency and BoP Crises • Constructed from large values in an index of currency pressure • Presumes that any nominal currency changes or reserve changes associated with exchange rate pressure should affect the PPP of the Domestic Currency

  10. Data Description • Control Variables in the Output Growth Equation • External Exogenous Factors • Lagged external growth rates • Openness to foreign trade • Lagged rate of real exchange rate overvaluation

  11. Empirical Results • Macro Developments: Before/After Statistics • .5% decline in GDP Growth in crisis year • Declines are not significant • Output goes back to previous level after two years • Inflation and Credit Growth are on a rising trend both before and after the crisis • Budget deficits rise modestly post crisis

  12. Benchmark Model Estimates • Model explains 35% of the variation in output growth • Emerging Markets that are more open grow faster • Emerging Markets are more adversely effected by turbulence in currency markets

  13. Conclusion • Research supports the view that currency crises in emerging markets are typically associated with substantial slowdown in economic growth • Major Crises do not appear to contract output to a larger extent than smaller crises

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