Sudden Stop (economics) - Empirical Issues

Empirical Issues

Empirical studies mention a group of indicators that may be related to sudden stops. The composition of capital inflows, with a higher proportion of short term financing may be more risky as they generate larger slowdowns in capital inflows. The time profile of maturity debt is important in assessing the potential for sudden reversals in capital flows. The shorter the maturity of a country’s debt, the more prone it is for a sudden stop crises.

Emerging markets

Some empirical studies focus on the interaction between sudden stops and financial crises in emerging market economies. Using a sample of emerging market countries with large capital inflows from Latin America, Asia and Europe, they compare the severity of the sudden stop episodes associated with currency crises and banking crises. The severity of sudden stop episodes in emerging market economies are compared using indicators such as the real depreciation of the currency and indicators of currency and banking crises. Results suggest that currency and banking crises in Asia in 1995-1997 were more severe than the sharpest crises in Latin America, in terms of banking bailout costs and the size of capital account reversal.

Another topic of study is the impact of sudden stops on output. Sudden stops can be accompanied by a currency crisis and/or a banking crisis. Empirical studies show that the effects of a banking crisis are more pernicious than the effects of a currency crisis, due to the additional effect of the credit channel on output. Lower asset prices are a persistent fact after a banking crisis, which indicate a low value of collaterals to loans, and therefore, negatively impact the banking sector and the supply of loans.

Regarding exports, currency crises show a faster recovery in the export sector, while exports remain low for an average of two years after banking crises. Banking crises also present a sharper recession, consistent with the disruption of the financial sector. There is a distinguishable boom–bust cycle, as unsustainable massive capital inflows that precede a sudden stop episode sharply increase economic activity.

Emerging markets and advanced economies

Other studies focus on the relationship between current account reversals and sudden stops in both emerging markets and advanced economies. Using cross-country data for a sample of 157 countries during the 1970-2001 period, the results indicate that 46.1% of countries that suffered a sudden stop also faced a current account reversal, while 22.9% of countries that faced current account reversals also faced a sudden stop episode. The less-than-one relationship could be related to an effective use of international reserves to offset capital outflows during sudden stops, while during current account reversals, there are some countries that were not receiving large capital inflows, so their deficits were financed through a loss of international reserves.

A comparison of the stylized facts observed during sudden stop episodes in emerging market economies and developed countries on the financial crises of the 1990s relate sudden stops in emerging market and advanced economies with the presence of contagion effects. Most sudden stop episodes for emerging markets occur around the Tequila (1994), East Asian (1997) and Russian (1998) crises. In the case of developed economies, sudden stop episodes occur around the European Exchange Rate Mechanism (ERM) (1992–1993) crisis.