Sudden Stops and Twin Crises

1
Sudden Stops and Twin Crises

•  Michael Hutchison and Ilan Noy

2
Sudden Stops?

• In particular, I willdiscuss 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)

3
Mexican Waves
4
Motivation

• Currency Crises Frequent
• Output Effects
• Examples
• Previous research
• Typology of currency crises
• Calvos sudden stop syndrome

5
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?

6
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.

7
 Methodology

• Estimate of output loss in the context of a
  dynamic model of output growth
• yit ayit-1 ??xit ??Dit ?it ui
• Dynamic panel estimates with endogeneity
• Why Panel framework?
• Hausman-Taylor IV estimator
• Arellano-Bond GMM estimator

8
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

9
Forecasts
10
Sudden Stops
11
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

12
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
13
Recent Sudden Stops
14
Sudden Stop ModelEstimated Dynamics
15
Calvo (1998, p. 47)

• High negative swings in capital inflows i.e.,
  sudden stops are dangerous.

16
Policyand future research

• Leading indicators
• Chile and Dr. Mahathir against the Washington
  Consensus?
• Caballeros insured capital flows?
• Liberalizing financial markets?
• What to do after-the-fact?