Compounded Effects of External Crises on GDP Growth
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Compounded Effects of External Crises on GDP Growth MARTIN MELECKY* School of Economics, University of New South Wales, Sydney NSW 2062, Australia. E-mail: [email protected]
This paper attempts to quantify possible negative effects of external crises on output in emerging market economies. The external crises considered are the current account reversals and currency crises. The direct effect (on GDP growth) and the indirect effect (through growth determinants) of an external crisis are estimated and compounded into an overall effect. An alternative approach to the analysis of the adjustment dynamics is applied. Comparative Economic Studies (2007) 49, 642–659. doi:10.1057/palgrave.ces.8100217
Keywords: External crises, growth cycles, emerging markets, panel data JEL Classifications: F32, F36, F43, C23
INTRODUCTION Models attempting to explain origins of the effects of external crises1,2 on economic performance feature multiple equilibria where the crisis is one of the possible outcomes. The negative effect of external crises on GDP growth is motivated by the existence of financial frictions such as liability dollarisation (see Aghion et al., 2005; Christiano et al., 2005), working capital constraints (as in Christiano et al., 2005), government guarantees to bank’s foreign creditors (as in Burnside et al., 2005), search frictions in the foreign investment decision (see Gopinath, 2004), underdeveloped financial markets that give rise to collective underinsurance (see Caballero and Krishnamurthy, 2005), or jumps of the shadow exchange rates (as eg in Guimaraes, 2006).
* Correspondence address: 2701 Calvert Street Washington DC, 20008, USA. 1 I thank Garry Barrett, Daniel Buncic, Lance Fisher, Adrian Foster, Paolo Giordani, Geoffrey Kingston, Lubos Komarek, Jan Libich, and Glenn Otto for helpful comments on an earlier draft of this paper. Financial assistance from the Australian Research Council is gratefully acknowledged. 2 Including currency crises and current account reversals analysed in this paper.
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The crises effects are then propagated through the economy, for instance, due to the financial accelerator effect, or currency and maturity mismatches on balance sheets. The approaches adopted for estimation of impacts of external crises on GDP growth can be roughly summarised into three groups. First, the so-called event studies look at stylised facts derived from the difference in the development of the most important macroeconomic variables before and after the crisis’ occurrence and draw some conclusions based on this (see eg Gupta et al., 2003; Aziz et al., 2000; Milesi-Ferretti and Razin, 1998, 2000). The second approach is to inspect significance of crises identification dummies in long-run growth regressions (5-year averages) as applied, for example, by Barro (2001). Third, the seemingly most popular approach investigates short-run growth regressions (using annual data) as, for example, Edwards (2001), Hutchis
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