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Emerging Market response to Developed Countries over recent periods of US recessions and crises: What changed? Regan DeonananUniversity of Notre Dame Thursday, 23rd June, 2011
Why 2007 US crisis of particular concern to Macroeconomists? • Three large facts: • Global nature of this US ‘recession’ • Largest downturn since Great Depression • Macroeconomic models did not predict it • Implication: • Contrary to previous belief, we still don’t know how to prevent them
Purpose of my research • How do we prevent developing countries from being so affected by global crises? • Need to understand what’s different about the 2007 crisis and why
Definitions • Emerging markets (EMs) – countries in the process of rapid growth • Examples: BRIC, Indonesia, Mexico, Poland • Developed countries (DCs) – countries with high level of development • Examples: Canada, France, Germany, Italy, Japan, UK, US (G7) • US recessions/crisis: 1981, 1990, 2001, 2007
Big picture from the data: Pair-wise correlations of rgdp growth between EMs and DCs
Main point from graph • EM growth became highly synchronized with DC growth/shocks in moving from 2001 to 2007 period – why?
Framework of empirical methodology • Assumptions: • DC fluctuations are the most important drivers of EM growth rates • EMs do not influence DC behavior • EM growth = US shock + Other DC shock + Prior EM growth + EM shocks
Intuition behind empirical methodology • What’s driving this recent change in EM response? • Size of shocks from DCs • Structural change within EM economy • What is the nature of the structural change? • Trade related • Financially related
Results: Ranking by level of structural change • 1. LATVIA • 2. LITHUANIA • 3. ESTONIA • 4. RUSSIA • 5. SLOVAKIA • 6. ROMANIA • 7. MALAYSIA • 8. KOREA • 9. MEXICO • 10. ARGENTINA • 11. THAILAND • 12. PERU • 13. TURKEY • 14. JORDAN • 15. CZECHOSLOVAKIA • 16. BRAZIL • 17. CHILE • 18. HUNDURAS • 19. POLAND • 20. SOUTH AFRICA • 21. MOROCCO • 22. COLUMBIA • 23. INDONESIA • 24. ISRAEL
Overall results • Structural change within EM economies played a greater role in explaining the change in behavior observed • This structural change was particularly oriented towards the US • This structural change left EMs more vulnerable to the US through trade and not through financial channels
Takeaway: EM response to DCs over various US recessions/crises– what changed? • Whenever the US economy goes down we can expect EM economies to also go down at the same time
Implications • Important from portfolio diversification viewpoint • If investing in EMs for high growth - fine • If motive for investing in EMs is balancing risk from investments in DCs, need to look to other countries • Important from macroeconomic stabilization viewpoint • As we seek to diversify our economies by going after EMs, need to ensure we develop relationships with other developing countries as a means of insuring away aggregate risk
Diversification and opportunities for growth of region • International investors will now be looking beyond EMs for investment opportunities • Natural progression will be to Frontier Markets, some of which can be found here in our region (eg. Jamaica, T&T) • Making Caribbean region for financially attractive has the potential, more than ever before, to bring in much needed investment