Sudden Stops and Twin Crises

 Michael Hutchison and Ilan Noy

Sudden Stops?

“In particular, I will…discuss the mechanics of a sudden stop in capital inflows (it need not result in capital outflows), and show that this could have large deleterious effects on the economy, validating the pessimistic conjectures that likely led to the initial stop.”

(Calvo, 1998, p. 36)

Mexican Waves

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

t-2 t-1 t t+1 t+2

Ou

tpu

t g

row

th

Indonesia (98) Korea (98) Mexico (95) Turkey (94)

Motivation

• Currency Crises Frequent

• Output Effects1.Examples

2.Previous research

• Typology of currency crises

• Calvo’s sudden stop syndrome

Objective.

• Estimates of average output costs of currency crises

- within a panel framework• Determine effect of Sudden Stops

- which are sharp capital account reversals at the same time a country is facing a currency crisis

• Were the consequences of the infamous crises of the 90s that surprising?

Literature - Theory.

• 1st and 2nd generations crisis models: no well-defined output effects.

• 3rd generation assume incomplete markets, incentive problems or informational asymmetries (might include output effects).

• The Sudden Stop syndrome (Calvo, 98).

• Additional papers on capital flow reversals and financial crises

• Earlier literature on credit constraints and the financial accelerator.

 Methodology

• Estimate of output loss in the context of a dynamic model of output growth

yit = αyit-1 + xit + γDit + it + ui

• Dynamic panel estimates with endogeneity: – Why Panel framework?– Hausman-Taylor IV estimator– Arellano-Bond GMM estimator

Hausman-Taylor IV estimator

• A weighted FGLS with IVs (deviations from country specific means).

• Estimated variances are obtained from the LS fixed effects regression and a 2SLS procedure.

• Specifying endogenous/exogenous variables– the crises variables are assumed endogenous

Forecasts

Sudden Stops

More Robustness…

• Major currency crises / banking crises• Major capital flow reversals• Selection bias (IMR)• Including reserves in the identification of reversals• Currency crisis identification using only the RER• Out-of-sample predictions

Out-of-sample Asia 1998

Output Growth in… Predicted Realized

Indonesia -5.1 -14.2

Korea -4.5 -6.9

Malaysia -5.0 -7.7

Philippines -5.2 -0.5

Thailand -4.9 -10.7

Recent Sudden Stops

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

t-2 t-1 t t+1 t+2

Ou

tpu

t g

row

th

Indonesia (98) Korea (98) Mexico (95) Turkey (94)

Sudden Stop Model

Estimated Dynamics

-12

-10

-8

-6

-4

-2

0

2

t-2 t-1 t t+1 t+2

Ou

tpu

t g

row

th

currency crisis capital flow reversal sudden stop crisis

Calvo (1998, p. 47):

“High negative swings in capital inflows – i.e., sudden stops – are dangerous.”

Policy…and future research

• Leading indicators• Chile and Dr. Mahathir against the Washington

Consensus?• Caballero’s insured capital flows?• Liberalizing financial markets?• What to do after-the-fact?