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Risk Factors in International Financial Crises: Early Lessons from the 2008-2009 Turmoil

Working paper by Dullien, Sebastian/ HTW, 2010

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This paper analyses the global transmission of the recent economic and financial crisis as a function of macroeconomic factors such as per capita gross domestic product, current-account positions prior to the crisis, exchange-rate regimes, inflation prior to the crisis and financial openness. It finds that large current-account imbalances (both surpluses and deficits) were a risk factor in the current global economic turmoil. It also finds that countries that use currency boards have suffered much more from the crisis than countries with other exchange-rate regimes. Financial openness appears to have increased the risk of experiencing a deep recession, while higher inflation prior to the crisis seems to have mitigated its impact.



Berlin Working Papers on Money, Finance, Trade and Development


In cooperation with


















Working Paper No. 01/2010


Risk factors in international financial crises: early
lessons from the 2008-2009 turmoil


Sebastian Dullien


July 2010





1


Risk factors in international financial crises: early lessons
from the 2008-2009 turmoil


By Sebastian Dullien
1


Abstract


This paper analyses the global transmission of the recent economic and financial
crisis as a function of macroeconomic factors such as per capita gross domestic
product, current-account positions prior to the crisis, exchange-rate regimes,
inflation prior to the crisis and financial openness. It finds that large current-account
imbalances (both surpluses and deficits) were a risk factor in the current global
economic turmoil. It also finds that countries that use currency boards have suffered
much more from the crisis than countries with other exchange-rate regimes.
Financial openness appears to have increased the risk of experiencing a deep
recession, while higher inflation prior to the crisis seems to have mitigated its
impact.


Keywords: crisis of 2008/9, exchange rate regimes, emerging markets, developing
countries


JEL classifications: E63, F31, F32


Introduction


There is a growing body of literature on the various impacts of the economic and financial


crisis on countries around the world. Much has been written on its impacts on world trade, on


commodity producing countries, on countries which have close trade linkages with the United


States, and on countries which rely heavily on remittance flows from developed countries.2


This paper aims to shed light on the spreading financial turmoil from a different angle: it


attempts to examine the international transmission of the subprime crisis in the United States


to determine which macroeconomic characteristics, beyond sectoral specialization and trade


specialization, make countries more vulnerable to the contagion effects of a global financial


and economic crisis. It looks at economic aspects which can be influenced by policymakers,


such as the exchange-rate regime, inflation, the current-account balance and capital-account


openness. In so doing, it adds to the debate on the choice of exchange-rate regimes, on


macroeconomic management, including under- or overvaluation of a currency, and on capital


account convertibility.



1 HTW Berlin – University of Applied Sciences, E-Mail: sebastian.dullien@htw-berlin.de
2 For a recent overview of a number of these issues, see Ocampo et al., 2010.





2


The paper is structured as follows. After a brief discussion on measuring the impact of the


crisis on individual countries, it provides a quantitative description of the most important


stylized facts of the global spread of the crisis, building on economic data for 181 countries


covered by the World Economic Outlook of the International Monetary Fund (IMF).3 It then


uses econometric techniques to determine which macroeconomic features helped some


countries to be more resilient to the financial and economic crisis than others. This section


also looks at the factors that might have played a role in determining whether a country


should turn to the IMF to cover financing needs in the recent crisis. The final section seeks to


offer tentative explanations for the empirical observations. Other contributions in this book


dwell on the wider implications of the findings, though these will also require further research


as more data become available.


1. Empirical analysis of the crisis


For determining the negative impact of the crisis, the following three criteria have been used


throughout the paper:


1. The change of trend in the GDP growth rate from the average of the years prior to the


crisis (2003–2007) to the average of the crisis years 2008–2009. This measure has


been chosen because the crisis hit different countries at different points in time. World


trade was already severely affected in the last quarter of 2008, and some countries


already had trouble financing their foreign deficit that year. However, due to the base


effect, this drop is partly reflected in the annual GDP growth rate in 2008 and partly in


2009. Looking only at the growth rate of one of these two years would have distorted


the picture.


2. The simple average growth rate of GDP for the years 2008 and 2009. Again, looking


at both years together gives a better picture than looking only at 2009 when most of


the decline occurred.


3. The fact that a country had to turn to the IMF for borrowing. Especially after the huge


wave of criticism of the IMF’s policies during the East Asian crisis of 1997–1998,


borrowing from the IMF has come to be seen not only as a national humiliation, but


also, increasingly, as an economic evil best avoided. Thus, being forced to accept IMF


lending can be viewed as a sign that a country has been severely affected by a crisis.



3 For this study, Zimbabwe has been excluded from the data set as it is an outlier for a number of the data points
considered, and the country’s recession is by most accounts largely independent of the global crisis.





3


Of course, there are other important negative economic and social consequences of the crisis,


such as rising unemployment and poverty, and increasing government debt. However, limited


availability of up-to-date data on these aspects constrains the analysis here. Unemployment


data are often not comparable between countries, and recording of unemployment figures,


especially for developing countries and emerging-market economies, are often inexact, as


employment in the informal sector is not always well covered. Moreover, the impact of the


crisis on the labour market may exhibit different time lags in different countries. In some


countries, retrenchment of workers is an easy and quick process, while in others it takes much


longer due to the legal regime or conventions. In addition, some countries have passed


measures temporarily stabilizing labour markets. Thus data currently available on labour


market performance are not an adequate indicator for measuring the impact of the crisis at this


particular point in time; its full impact can only be evaluated later.


Reporting of government debt and government budget deficits outside the OECD countries is


also not very exact and up-to-date, and the IMF’s World Economic Outlook therefore provides


such data for only a limited number of countries. Similarly, due to the lack of reliable, up-to-


date statistics for the incidence of poverty across countries, it is difficult to assess to what


extent poverty has increased as a result of the crisis. While there have been a number of


estimates (i.e. Chen and Ravallion, 2009), these are necessarily only very rough. These


indicators have therefore been omitted from this paper; instead, the paper focuses on the drop


in GDP and the extent of IMF involvement.


The analysis in this paper is based on data assembled from various sources. Data on GDP,


inflation and current accounts have been taken from the IMF’s World Economic Outlook


database (January 2010). Data on capital-account openness have been derived from Chinn and


Ito (2008). And data on exchange-rate regimes have been taken from the IMF’s classification


of exchange-rate regimes (IMF, 2009) and modified to include an additional group of


countries in the European Monetary Union (EMU).4 Altogether, the sample comprises 179


countries.


1.1 Descriptive statistics


Before we turn to a rigorous econometric analysis, it is useful to take a brief look at the data.


At the beginning of the crisis, it was often argued by the IMF and financial sector analysts



4 The IMF classifies EMU countries as “independently floating”. While this might be an appropriate description
of EMU as a whole, it is misleading when looking at the performance of individual member countries such as
Greece, as that country has a fixed exchange rate with its main trading partners.





4


that the emerging-market economies and developing countries might be decoupled from


developed economies, particularly the United States, and may therefore be able to cope with


the turmoil more effectively. While this hope proved to be illusory, at least some emerging-


market economies have performed much better than other parts of the world. Asian countries,


in particular, have managed to recover very quickly and briskly from the crisis, with parts of


Latin America following. In contrast, economic data for most of the members of the


Commonwealth of Independent States (CIS) and the new member States of the European


Union (EU) have shown few real improvements. Also the United States and the Western


European industrialized economies have proved to be laggards, with vulnerable economic


recovery (IMF, 2010).


Beyond these regional features, however, the impact of the crisis has clearly varied with the


state of development of the economies in question.5 On examining the different categories of


countries, namely low-income countries (GDP per capita below $975), lower middle-income


countries (GDP per capita between $976 and $3,855), upper middle-income countries (GDP


between $3,858 and $11,905) and high-income countries, we found fairly large variations in


the fall in the growth between the years 2003–2007 and 2008–2009: high-income countries


experienced a drop in the growth rate of 5.2 percentage points,6 upper middle- income


countries saw an almost equally large drop of 4.9 percentage points, while lower middle-


income countries saw growth decline by 2.7 percentage points and lower income countries by


only 1.2 percentage points. The group of high-income countries was the only category which


recorded an average annual negative growth rate for the years 2008 and 2009 of minus 0.7


per cent. This group therefore was solely responsible for the contraction of world GDP in


2009.


The crisis has also seen a resurgence of borrowing from the IMF. After years of not being


able to find borrowers, the IMF has started to lend again, supported by a pledge by its


shareholders to provide more funding as part of internationally coordinated crisis-fighting


efforts. Net disbursements by the Fund have been higher than at any time since the mid-


1980s, with net payouts totalling more than 20 billion in Special Drawing Rights (SDRs)


(about US$ 30 billion) in 2009 (figure 1). Also, the number of countries borrowing from the


IMF has risen sharply: out of 179 countries in our sample, 53 received IMF funding in 2009 –


a share of almost 30 per cent.



5 For descriptive statistics on the impact of the crisis on different economies, see the table in the annex.
6 All data for each country group refer to simple, unweighted averages for the country group in question.





5






Figure 1: Net IMF loan disbursements





-30 000


-20 000


-10 000


0


10 000


20 000


30 000


1
9


8
4


1
9


8
5


1
9


8
6


1
9


8
7


1
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8
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1
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1
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0


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1
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9
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1
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1
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9
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1
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9
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1
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9
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2
0


0
0


2
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0
1


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0


0
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0


0
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2
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0
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2
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0
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S
D


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il


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Source: author's calculations, based on data from IMF website






The impact of the crisis has clearly varied with the size of the external imbalances of


individual countries. Dividing the sample into four country groups according to their current-


account positions prior to the crisis (those with a high current-account surplus of more than 5


per cent of GDP, those with a current-account surpluses of less than 5 per cent of GDP, those


with a current-account deficit of more than 5 per cent of GDP and those with a current-


account deficit of less than 5 per cent of GDP), it can be observed that countries with large-


current account imbalances – surpluses or deficits – have been hit harder than those with


moderate imbalances. The group with very high surpluses experienced a drop in the growth


trend by 4.2 percentage points, followed by an only slightly smaller drop in the growth trend


of 3.9 percentage points for the group with very high deficits. In contrast, countries with





6


moderate deficits and those with moderate surpluses experienced a decline of only 2.2


percentage points and 3.1 percentage points respectively (figure 2).


Figure 2: Change in GDP growth between 2003–2007 and 2008–2009 by current-


account position of countries (Percentage points)






The exchange-rate regime also seems to have an impact on the vulnerability of a country to


the contagion effects of a crisis. After the Asian crisis in the 1990s, the notion of the stable


corner solutions (“corner solution paradigm”) came into vogue. According to this proposition,


in the long run only two currency regimes would be stable: the completely fixed or the


completely flexible exchange rate.7 Proponents of this hypothesis understood by “completely


fixed” any regime which was then seen as providing an irrevocably fixed exchange rate,


thereby providing no room for speculation. In addition to dollarization, currency boards and


monetary union were also seen as belonging to this category of exchange-rate regimes,



7 Early proponents include Eichengreen, 1994, and Obstfeld and Rogoff, 1995.





7


because, in principle, under these regimes the authorities have the necessary means in the


form of reserves to prevent any crack in the exchange-rate peg.8


In order to get an idea of the initial impact of the exchange-rate regime on the vulnerability of


countries, the sample was divided into nine groups, using the IMF’s classification of


exchange-rate regimes plus a separate group for countries in the EMU.9 Again, the results are


quite revealing. The (small) group of dollarized economies, including countries such as


Ecuador, Montenegro and Panama,10 managed the crisis relatively well: their GDP growth fell


by only 0.6 percentage points, and growth continued at an average rate of 3.7 per cent in


2008–2009 – above average in the overall sample. None of these countries had to seek IMF


support. However, before taking this result as a strong endorsement of dollarization, it must


be borne in mind that the countries which lacked a legal tender of their own had been growing


less rapidly in the years prior to the crisis than other countries of similar income levels (see


annex table). In addition, abandoning the national currency deprives policy makers of the


possibility of domestic financing of investment, as noted in Dullien (2009). Countries having


the other types of exchange-rate regimes originally considered as “completely fixed” have


performed comparatively badly during the crisis. The group of currency board countries,


including Bulgaria and Estonia, but also some smaller Caribbean countries, have been the


worst affected. GDP growth there declined, on average, by a whopping 6 percentage points.


In addition, these countries experienced a contraction in average annual GDP of 1 per cent in


2008 and 2009.


Interestingly, the exchange-rate regimes that, on average, produced the best outcome during


the crisis are those in the “middle ground” which were once seen as not sustainable. Countries


which had exchange-rate regimes classified as “conventional fixed peg” (except currency


boards, monetary union and dollarization), “pegged exchange rate within horizontal bands”,


“crawling pegs” or “crawling bands” saw their GDP growth rates decline by an average of


only 3 percentage points, and they achieved an average annual GDP growth rate of 3 per cent


in 2008 and 2009, while those with exchange-rate regimes closer to the “corners” saw their



8 Of course, the Argentine crisis of 2001-2002, which resulted in its exit from a currency board, showed that
such a regime is certainly not an “irrevocably fixed” exchange-rate regime.
9 The IMF classifies EMU countries as “independently floating”. While this might be an appropriate description
of EMU as a whole, it is certainly misleading when looking at the performance of a single member country such
as Greece as that country has a fixed exchange rate with its main trading partners.
10 Countries are counted as “dollarized” if they have adopted a foreign currency. Thus, Montenegro is considered
as having a “dollarized” economy even though it uses the euro.





8


GDP growth rate decline by 3.8 percentage points and recorded an average annual GDP


growth rate of only 1.2 per cent.










Table 1: Impact of the crisis by different exchange-rate regimes




















1.2 Econometric estimates


Descriptive statistics like those above can be misleading. For example, currency board


countries as a group also usually have high current-account deficits. The question is therefore


whether the factors analysed above have a direct influence on their own, or only an indirect


influence. This can only be answered by means of rigorous econometric testing. Thus, as a


first step, a regression was run with the change in GDP growth between 2003–2007 and


2008–2009 as the dependent variable, and the current-account balance prior to the crisis


(2007), the inflation rate prior to the crisis (2007), GDP per capita, the variable for capital-


account openness, a dummy for an IMF programme in 2009 and dummies for the different


types of exchange-rate regimes as independent variables. In a general-to-specific-approach,


Change in GDP


growth, 2008–


2009


compared


with 2003–


2007


(Percentage


points)


Average


annual GDP


growth, 2008–


2009


(Per cent)


Average annual


GDP growth


2003–2007


(Per cent)


Dollarized economies -0.6 3.7 4.3


Currency board arrangements -6.0 -1.0 5.1


Free float -4.2 -0.1 4.1


Managed float -3.2 3.0 6.2


European Monetary Union -4.3 -1.3 3.0


Others ("middle ground")* -3.0 3.0 5.9


* Other conventional fixed peg arrangements, pegged exchange rate within horizontal


bands, crawling peg, crawling band.
Source: Author’s calculations, based on the IMF’s World Economic Outlook Database
(accessed in January 2010) and IMF (2009)





9


variables that were not significant, at least at a 10 per cent level, were eliminated. In addition,


both the current-account balance and the absolute value of the current-account balance were


alternatively included in order to allow for the possibility that large surpluses also make a


country vulnerable. The final equation for the change in the growth trend during the crisis


reads as follows:


,


where is the percentage point change in the average annual growth rate between


2003–2007 and 2008–2009, is GDP per capita in current US$ 1,000, and


is the absolute value of the current account in 2007 as a per cent of


GDP.


From this it can be observed that only per capita GDP levels and current-account imbalances


had a clearly negative influence on the way a country was affected by the crisis (both


coefficients are significant at the 5 per cent level), where the impact was measured as a


change in the trend growth rate. Countries with higher per capita incomes have been hit


significantly harder by the crisis than those with lower incomes. Interestingly, the current-


account balance as a per cent of GDP was insignificant in explaining the change in GDP


growth, while the absolute value of the current-account balance as a per cent of GDP turned


out to be highly significant. Hence, not only current-account deficits appear to have


contributed to the propagation of the crisis, but also current-account surpluses.


In a second step, a regression analysis was undertaken of the current-account balance prior to


the crisis (2007), the inflation rate prior to the crisis (2007), GDP growth rate prior to the


crisis (2003 to 2007), GDP per capita, the variable for capital-account openness, a dummy for


an IMF programme in 2009 and dummies for the different types of exchange-rate regimes as


possible factors influencing the average annual rate of GDP growth in 2008-2009. As before,


variables which turned out to be statistically insignificant were eliminated, and both the


current-account balance and the absolute value of the current-account balance were tested.


The resulting equation reads:





10




Where is the average annual growth rate of GDP in 2008 and 2009,


is the average annual growth rate of GDP during the period 2003–2007,


is the current account position as a per cent of GDP in the year 2007,


is the rate of inflation in 2007 and is a dummy for the country using a currency


board.




All variables were significant at the 5 per cent level, except inflation and the GDP growth rate


for the period 2003–2007 which were significant at 10 per cent.


A few of the results are notable. First, again GDP per capita turned out to be a very strong


predictor of lower growth in the crisis years, even when controlling for growth prior to the


crisis. One reason might be that the crisis originated in some of the most developed countries.


Second, the current-account deficit, not the absolute value, seems to be a significant variable.


A larger deficit prior to the crisis led to lower growth during the crisis years. Third, countries


with a currency board in place had a significantly lower growth rate in 2008–2009 (by an


annual two percentage points on average), even after controlling for the effects of the huge


current-account deficits some of the currency board countries such as Lithuania and Estonia


were running prior to the crisis. Third, inflation prior to the crisis seems to have influenced


the impact of the crisis, but not in the way that would be predicted by standard theory. In


actual fact, a higher rate of inflation prior to the crisis was correlated with a higher growth


rate during the crisis (even when controlling for GDP growth prior to the crisis).


Another interesting feature seems to be the lack of any correlation between the depth of the


crisis in a country and its request for IMF support. This result would mean first that countries


seem to have sought IMF support regardless of the scale of their economic downturn, and


second, that the IMF programmes do not appear to have significantly influenced the growth


outcomes of those countries compared with other countries having similar characteristics.





11


In a third step, a probit approach was used to test which characteristics increased the


probability of a country seeking IMF support. Again, all variables were initially included and


subsequently eliminated. In the end, the probit model for the probability of an IMF


programme was estimated (table 2).


Table 2: Probit model: Probability of IMF intervention






Variable Coefficient Standard error


Constant -0.575 0.151 (***)




-0.056 0.011(***)




-0.392 0.118 (***)


*** significant, at 1 per cent
level




Only two variables are significant for explaining the need for an IMF programme: the current-


account balance and the GDP per capita. The larger the current-account deficit prior to the


crisis, the larger was the probability of a country seeking IMF assistance in response to the


crisis. In fact, looking at the descriptive statistics, it can be seen that only 2 out of the 53


countries which borrowed from the IMF in 2009 had a current-account surplus prior to the


crisis. In addition, the richer a country in per capita terms, the less likely it was to seek IMF


intervention. This is an interesting result, as IMF intervention was considered most likely for


emerging-market economies. During the crisis, however, the Fund has lent strongly also to


lower income countries. None of the exchange-rate regime dummies proved to be


significant.11



11 However, some of the exchange-rate regime dummies showed a 100 per cent correlation with no IMF
programmes. For example, no dollarized country turned to the IMF in the latest crisis. However, interpreting this
fact in economic terms is not straightforward. While proponents of dollarization might claim that this shows the
greater stability of dollarized economies, it is just as plausible that dollarized economies lack the channels for
intervention through an IMF loan, or that the number of dollarized economies was too small (5 out of 179) to
enable a reliable conclusion to be drawn.





12


Finally, the group of worst performers during the crisis was selected and another probit


estimation run on the characteristics of this group. To this end, a threshold of an annual


contraction by more than 3 per cent for 2008–2009 was chosen (a total contraction of more


than 6 per cent), which produced 12 countries: Armenia, Botswana, Estonia, Hungary,


Iceland, Ireland, Italy, Japan, Latvia, Lithuania, Seychelles and Ukraine. The probit


estimation for these countries yielded the results presented in table 3, with KOpen referring to


capital-account openness as measured by the Chinn/Ito index.




Table 3: Probit model: Probability of a deep recession




Variable Coefficient Standard error


Constant -2.671 -2.671 (***)




-0.028 0.013(**)




0.154 0.857 (*)




0.092 0.055 (*)


KOpen 0.262 0.122 (**)


*** significant at 1 per cent level
** significant at 5 per cent level
* significant at 10 per cent level




Thus again, having a higher GDP per capita generally increases the risk of experiencing a


severe recession. A large current-account deficit prior to the crisis is also an important risk


factor. Having a relatively open capital account seems to be another risk factor for suffering


severe consequences of a global financial and economic crisis. Our regression analysis


revealed yet another factor: experiencing very strong growth in the years 2003–2007 (i.e. just


prior to the crisis) also seemed to have increased the risk of the crisis plunging a country into


a deep recession. This finding hints that a boom prior to the crisis might have led to


imbalances, which made the economy in question more vulnerable (as it might have been part





13


of a boom-and-bust cycle). Finally, having a very open capital account, as measured by the


Chinn/Ito index, significantly increased the risk of experiencing a very deep recession as a


consequence of the United States subprime crisis.


1.3 Summing up the empirical evidence


Thus, the findings may be summarized as follows:


1. In terms of impact on GDP and GDP growth, the crisis appears to have affected high-


and upper middle-income countries more than poorer countries, even though there


may have been greater suffering in lower income countries, as a drop in GDP growth


might be more severe in an environment without social safety nets and widespread


poverty as a result of the crisis.


2. Large current-account imbalances – not only deficits – seem to be an important risk


factor for vulnerability to crisis transmission.


3. Currency boards seem to be an additional risk factor, in addition to the impact a


currency board might have on the external balance by increasing the current-account


deficit.


4. An open capital account appears to exacerbate vulnerability.


5. Inflation, long seen as a prime concern for macroeconomic stability and an important


factor in increasing countries’ vulnerability to financial and currency crises, does not


seem to be as significant a factor as was previously thought.


6. Higher per capita incomes make IMF intervention less likely.


7. IMF programmes cannot be shown to have significant positive or negative effects on


the depth of a crisis


2. Tentative explanations and conclusions


From a theoretical point of view, and against the background of the Washington Consensus,


these results provide the basis for considerable rethinking. First, the benefits of free global


capital flows are very difficult to detect in this data set. Economic textbook theory tells us that


open capital accounts can do two things. First, they can help countries which lack capital to


import capital to grow faster. They can borrow from abroad, invest and hence boost growth.





14


As marginal productivity of capital is higher than in countries which are capital-abundant,


they can easily use the proceeds from their investments to service their debt. Second, open


capital accounts can help countries weather asymmetric shocks. If an unexpected shock


lowers national income, borrowing from abroad can be used to smooth national consumption,


thus increasing welfare.12 As long as domestic consumption has an influence on domestic


output, this should also help reduce the volatility of overall output. Countries which are more


financially open can more easily borrow from abroad, and therefore should be able to


withstand a crisis – such as the recent one – better.


However, the data presented in this paper do not confirm this story. Whether importing capital


is a sensible strategy for sustainably accelerating economic growth has been disputed for a


number of years (see, for example, Prasad, Rajan and Subramanian, 2007). The data set used


in this paper raises doubts about the ability of capital inflows to smooth the economic cycle.


While an open capital account per se does not seem to have a significant influence on the


depth of a crisis for the whole sample, it seems to increase the probability that a global


economic and financial crisis can push a country with such an account into a deep recession.


Moreover, using the possibility of global capital flows, either as an exporter or an importer of


large amounts of capital (as reflected in a large current-account imbalance) clearly and


strongly adds to a country’s vulnerability to a crisis. One plausible explanation would be that


in a financial crisis, such as the current one, access to foreign finance might not be possible


due to a sudden increase in risk aversion among investors, thereby hurting countries that have


relied on external capital inflows. The significant impact on countries with large surpluses


might be explained by the fact that the large surpluses possibly hint at macroeconomic


imbalances in these countries prior to the crisis in the form of permanently insufficient


domestic demand. With borrowers being cut off from the global financial markets during the


current crisis, countries that relied on other countries’ demand growth for their own economic


growth were hit disproportionally, due to the lack of internal demand growth momentum to


make up for the loss of external demand.


The probability of entering a very deep recession might increase in proportion to the openness


of the capital account. This is because capital controls are usually geared more towards short-


term capital flows, and hence a more open capital account means a larger share of volatile


short-term inflows in the overall capital inflows of a country. Given that the benefits of free


capital flows do not seem to materialize as promised to the countries which – at least in the



12 For a typical detailed explanation, see Feenstra andTaylor, 2008, chap. 17.





15


textbook model – should profit most from them (because they have made most use of


international capital flows), there might be a case for introducing controls and limits on global


capital flows.


Of course it may seem somewhat inappropriate to use the recent crisis as evidence against the


textbook argument of the cushioning effects of global capital flows. After all, the textbook


argument is in general about supply-side shocks to national output, while the origin of the


latest crisis has clearly been a financial one. However, given the magnitude of the crisis and


the fact that most of the economic crises of the past few decades arguably had financial


origins, one has to question the relevance of the argument in favour of insuring against


national supply shocks compared to potential shocks created by international capital flows for


an individual economy.


If one agrees with the necessity of proactive macroeconomic management to limit current-


account imbalances, and the need for bold policy action to counteract potential crises, the


other results are rather easy to explain: moderate rates of inflation (instead of low rates) are


not necessarily a problem, but might provide more space for monetary policy to implement


rate cuts before the zero bound limits further actions. Such a stance could be considered as


supporting the conclusions drawn by a recent IMF paper on the optimum rate of inflation


(Blanchard, Dell’Ariccia and Mauro, 2010). Currency boards are a danger as they create a


false sense of security and make proper macroeconomic management aimed at limiting


current-account imbalances virtually impossible.


More puzzling is the fact that IMF involvement does not seem to have any explanatory power


for the depth of a recession or a slowdown in growth. This result might be uncomfortable both


for the IMF itself as well as its critics. If it turns out to be robust, it would mean that IMF


involvement does not necessarily stabilize economic growth (as measured in GDP terms), nor


does the conditionality attached to IMF programmes exacerbate the short-term impact of a


crisis, as was repeatedly claimed for IMF programmes during the Asian crisis (Stiglitz, 2002).


It might also indicate that there has been a change in the way the IMF designs its adjustment


programmes so as to reduce their negative short-term impact on GDP growth compared with


the IMF programmes of previous decades, as some observers claim (Schieritz, 2010). Turning


this evidence against the IMF would imply that its programmes, while not exacerbating the


economic situation, have not contributed much towards economic stabilization in the latest


crisis.





16


From an economic policy perspective, this means that emerging-market economies and


developing countries should think twice about opening up their capital accounts. Should they


decide to open their capital accounts, countries should undertake active macroeconomic


management to prevent the emergence of large current-account imbalances, even if this comes


at the price of higher inflation. Finally, the results are a clear warning against creating a


currency-board framework. Far from providing a stable macroeconomic environment, as


some proponents have long argued, empirically such a framework seems to amplify shocks.


References


Blanchard O, Dell’Ariccia G and Mauro P (2010). Rethinking macroeconomic policy. IMF


Staff Position Note 10/03, Washington, DC.


Chen S and Ravallion M (2009). The impact of the global financial crisis on the world’s


poorest. VoxEU; available at: http://www.voxeu.org/index.php?q=node/3520.


Chinn MD and Ito H (2008). A new measure of financial openness. Journal of Comparative


Policy Analysis, 10(3): 307–320.


Dullien S (2009) Central banking, financial institutions and credit creation in developing


countries. UNCTAD Discussion Papers 193, United Nations Conference on Trade and


Development, Geneva.


Eichengreen B (1994). International monetary arrangements for the 21st century. Washington,


DC, Brookings Institution.


Feenstra RC and Taylor AM (2008). International Economics. New York: Worth Publishers.


IMF (2009). De facto classification of exchange rate regimes and monetary policy


frameworks (as of April 31, 2008); available at:


http://www.imf.org/external/np/mfd/er/2008/eng/0408.htm.


IMF (2010), World Economic Outlook, April, Washington, D.C.


Obstfeld M and Rogoff K (1995). The mirage of fixed exchange rates. Journal of Economic


Perspectives, 9 (4): 73–96.


Ocampo JA et al. (2010). The great recession and the developing world. Initative for Policy


Dialogue Working Paper; available at:





17


http://www0.gsb.columbia.edu/ipd/pub/Crisis_Complutense%5B1%5D_Great_Recessio


n.pdf.


Prasad ES, Rajan R and Subramanian A (2007). Foreign capital and economic growth.


Brookings Papers on Economic Activity, 38: 153–230.


Schieritz M (2010). Waschlappen aus Washington. DIE ZEIT Nr. 14/2010: 16.


Stiglitz J (2002). Globalization and its Discontents. New York: W.W. Norton & Co. Inc.





18


Annex


Table A.1: Impact of the crisis, by country categories




Number of
countries


Number of


countries


with IMF


lending in


2009


Change in


GDP


growth,


2008–2009


vs. 2003–


2007


(percentage


points)


Average


annual GDP


growth,


2008–2009


Average


current-


account


position,


2007


Absolute


average


current-


account


position in


2007


Average


inflation,


2007


Average


annual


growth,


2003–2007


Average


Chinn/Ito


index for


capital-


account


openness


Total sample 179 53 -3.5 2.0 -3.1 10.7 6.1 5.4 0.5


Per capita GDP less


than $976


44 26 -1.2 4.3 -7.0 8.8 8.4 5.4 -0.5


Per capita GDP


between $975 and $3


855


45 14 -2.7 3.3 -3.5 9.4 6.8 6.1 0.3


Per capita GDP


between $3 856 and


$11 905


42 10 -4.9 1.0 -5.0 13.0 6.3 5.9 0.2


Per capita GDP more


than $11 905


48 3 -5.2 -0.7 2.4 11.7 3.3 4.5 1.8


Current-account


surplus of less than


5% of GDP


21 0 -3.1 1.8 2.2 2.2 3.8 5.0 1.2





19


Current-account


surplus of more than


5% of GDP


40 2 -4.2 2.6 15.8 15.8 7.5 6.8 0.4


Current-account


deficit of less than 5%


of GDP


34 14 -2.2 2.6 -2.4 2.4 6.6 4.8 0.1


Current-account


deficit of more than


5% of GDP


84 37 -3.9 1.3 -13.8 13.8 5.9 5.2 0.5


Severe recession 12 6 -11.5 -5.4 -8.6 11.7 5.8 6.1 1.8


IMF lending in 2009 53 53 -2.9 2.2 -12.3 12.9 6.8 5.1 0.1


Dollarized economies 5 0 -0.6 3.7 -7.9 9.3 3.7 4.3 1.4


Economies with


currency boards


13 7 -6.0 -1.0 -18.2 27.9 3.9 5.1 0.8


Economies with


managed floating


currencies


43 17 -3.2 3.0 -5.0 9.8 8.3 6.2 0.6


Economies with free


floating currencies


23 4 -4.2 -0.1 -1.4 6,1 3.5 4.1 1.3


European Monetary


Union


15 0 -4.3 -1.3 -2.1 6.6 2.2 3.0 2.1


Economies with


"middle ground"


exchange rate


regimes


78 24 -3.0 3.0 -0.1 10.8 6.9 5.9 -0.2


Source: Author’s calculations, based on IMF (2009) and the IMF World Economic Outlook database (accessed January 2010).






 
 
 
 
 






































Publisher: Competence Center “Money, Finance, Trade and Development “ 
HTW-Berlin – Treskowallee 8, 10318 Berlin
Prof. Dr. Sebastian Dullien, Prof. Dr. Jan Priewe

http://finance-and-trade.htw-berlin.de





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