Output Costs of Currency Crises: Shocks, Policies and Cycles

Nakatani, Ryota (2018): Output Costs of Currency Crises: Shocks, Policies and Cycles.

Abstract

This paper studies output declines during currency crises based on the theoretical model by Nakatani (2016, 2017a), highlighting the role of shocks that trigger crises. Using panel data on 49 developing countries, we find that both productivity shocks in the real sector and shocks to the country’s risk premium in financial markets affect the output costs of currency crises, which are 4% of GDP on average and 8% for severe crises. During severe currency crises in Asian and Latin-American countries, both productivity shocks and exchange rate overvaluation were found to be important factors in explaining large output losses.

• Item Type: MPRA Paper
• Language: English
• Keywords: Growth; Currency Crisis; Productivity; Risk Premium; Exchange Rate Overvaluation; Developing Countries
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F43 - Economic Growth of Open Economies; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O47 - Empirical Studies of Economic Growth ; Aggregate Productivity ; Cross-Country Output Convergence

References

Arellano, Manuel and Stephen Bond. 1991. “Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations” Review of Economic Studies 58: 277-297.

Basistha, Arabinda and Sheida Teimouri. 2015. “Currency Crises and Output Dynamics” Open Economies Review 26: 139-153.

Bordo, Michael, Barry Eichengreen, Daniela Klingebiel and Maria Soledad Martinez-Peria. 2001. “Is the Crisis Problem Growing More Severe?” Economic Policy 16: 53-82.

Bowsher, Clive G. 2002. “On Testing Overidentifying Restrictions in Dynamic Panel Data Models” Economics Letters 77: 211-220.

Burnside, Craig, Martin Eichenbaum and Sergio Rebelo. 2004. “Government Guarantees and Self-Fulfilling Speculative Attacks” Journal of Economic Theory 119: 31-63.

Bussière, Matthieu, Sweta C. Saxena and Camilo E. Tovar. 2012. “Chronicle of Currency Collapses: Re Examining the Effects on Output” Journal of International Money and Finance 31: 680-708.

Caballero, Ricardo J. and Arvind Krishnamurthy. 2001. “International and Domestic Collateral Constraints in a Model of Emerging Market Crises” Journal of Monetary Economics 48: 513-548.

Cerra, Valerie and Sweta C. Saxena. 2008. “Growth Dynamics: The Myth of Economic Recovery” American Economic Review 98: 439-457.

Céspedes, Luis Felipe, Roberto Chang and Andrés Velasco. 2004. “Balance Sheets and Exchange Rate Policy” American Economic Review 94: 1183-1193.

Cole, Harold L. and Timothy J. Kehoe. 1996. “A Self-Fulfilling Model of Mexico’s 1994-1995 Debt Crisis” Journal of International Economics 41: 309-330.

Corsetti, Giancarlo, Paolo Pesenti and Nouriel Roubini. 1999. “Paper Tigers? A Model of the Asian Crisis” European Economic Review 43: 1211-1236.

Dekle, Robert and Kenneth M. Kletzer. 2002. “Domestic Bank Regulation and Financial Crises: Theory and Empirical Evidence from East Asia” in S. Edwards and J. A. Frankel (eds.) Preventing Currency Crises in Emerging Markets, The University of Chicago Press, pp.507-552.

Dooley, Michael P. 2000. “A Model of Crises in Emerging Markets” Economic Journal 110: 256-272.

Gupta, Poonam, Deepak Mishra and Ratna Sahay. 2007. “Behavior of Output During Currency Crises” Journal of International Economics 72: 428-450.

Hong, Kiseok and Aaron Tornell. 2005. “Recovery from a Currency Crisis: Some Stylized Facts” Journal of Development Economics 76: 71-96.

Hutchison, Michael M. and Ilan Noy. 2002. “Output Costs of Currency and Balance of Payments Crises in Emerging Markets” Comparative Economic Studies 44: 27-44.

Hutchison, Michael M. and Ilan Noy. 2005. “How Bad Are Twins? Output Costs of Currency and Banking Crises” Journal of Money, Credit and Banking 37: 725-752.

Hutchison, Michael M. and Ilan Noy. 2006. “Sudden Stops and the Mexican Wave: Currency Crises, Capital Flow Reversals and Output Loss in Emerging Markets” Journal of Development Economics 79: 225-248.

Kaminsky, Graciela L. and Carmen M. Reinhart. 1999. “The Twin Crises: The Causes of Banking and Balance-of-Payments Problems” American Economic Review 89: 473-500.

Klein, Michael W. and Jay C. Shambaugh. 2008. “The Dynamics of Exchange Rate Regimes: Fixes, Floats, and Flips” Journal of International Economics 75: 70-92.

Krugman, Paul. 1979. “A Model of Balance-of-Payments Crises” Journal of Money, Credit and Banking 11: 311-325.

Laeven, Luc and Fabián Valenica. 2014. “Systemic Banking Crises” in S. Claessens, M. A. Kose, L. Laeven and F. Valenica (eds.) Financial Crises: Causes, Consequences, and Policy Responses, International Monetary Fund, pp.61-137.

McKinnon, Ronald I. and Huw Pill. 1999. “Exchange-Rate Regimes for Emerging Markets: Moral Hazard and International Overborrowing” Oxford Review of Economic Policy 15: 19-38.

Nakatani, Ryota. 2014. “The Effects of Financial and Real Shocks, Structural Vulnerability and Monetary Policy on Exchange Rates from the Perspective of Currency Crises Models” UTokyo Price Project Working Paper Series No.061, Graduate School of Economics, University of Tokyo. http://www.price.e.u-tokyo.ac.jp/img/researchdata/pdf/p_wp061.pdf

Nakatani, Ryota. 2016. “Twin Banking and Currency Crises and Monetary Policy” Open Economies Review 27: 747-767.

Nakatani, Ryota. 2017a. “Structural Vulnerability and Resilience to Currency Crisis: Foreign Currency Debt versus Export” The North American Journal of Economics and Finance 42: 132-143.

Nakatani, Ryota. 2017b. “The Effects of Productivity Shocks, Financial Shocks and Monetary Policy on Exchange Rates: An Application of the Currency Crisis Model and Implications for Emerging Market Crises” Emerging Markets Finance and Trade 53: 2545-2561.

Nakatani, Ryota. 2017c. “Real and Financial Shocks, Exchange Rate Regimes and the Probability of a Currency Crisis” MPRA Paper No.82186, University Library of Munich, Germany.

Nakatani, Ryota. 2017d. “External Adjustment in a Resource-Rich Economy: The Case of Papua New Guinea” IMF Working Paper No.17/267.

Nakatani, Ryota. 2018. “Real and Financial Shocks, Exchange Rate Regimes and the Probability of a Currency Crisis” Journal of Policy Modeling, forthcoming. https://doi.org/10.1016/j.jpolmod.2017.10.004

Nakatani, Ryota, et al. 2017. “The 'New Mediocre' and the Outlook for Productivity in Asia” in Regional Economic Outlook. Asia and Pacific: Preparing for Choppy Seas, April 2017, IMF, pp.77-106. https://www.researchgate.net/publication/316952482_The_New_Mediocre_and_the_Outlook_for_Productivity_in_Asia

Obstfeld, Maurice. 1996. “Models of Currency Crises with Self-Fulfilling Features” European Economic Review 40: 1037-1047.

Reinhart, Carmen M. and Kenneth S. Rogoff. 2013. “Banking Crises: An Equal Opportunity Menace” Journal of Banking & Finance 37: 4557-4573.

Romer, Christina D. and David H. Romer. 2017. “New Evidence on the Aftermath of Financial Crises in Advanced Countries” American Economic Review 107: 3072-3118.

Roodman, David. 2009. “A Note on the Theme of Too Many Instruments” Oxford Bulletin of Economics and Statistics 71: 135-158.

Schneider, Martin and Aaron Tornell. 2004. “Balance Sheet Effects, Bailout Gurantees and Financial Crises” Review of Economic Studies 71: 883-913.

Tajika, Eiji and Ryota Nakatani. 2008. “Welcome Home to Japan: Repatriation of Foreign Profits by Japanese Multinationals” Discussion Papers No. 2008-04, Graduate School of Economics, Hitotsubashi University. http://hermes-ir.lib.hit-u.ac.jp/rs/bitstream/10086/16994/1/070econDP08-04.pdf

Teimouri, Sheida and Taggert J. Brooks. 2015. “Output Recovery After Currency Crises” Comparative Economic Studies 57: 75-102.

Wan, Chao and Yuying Jin. 2014. “Output Recovery After Financial Crises: An Empirical Study” Emerging Markets Finance and Trade 50: 209-228.

Windmeijer, Frank. 2005. “A Finite Sample Correction for the Variance of Linear Efficient Two-Step GMM Estimators” Journal of Econometrics 126: 25-51.