Working Paper: CEPR ID: DP1921
Authors: Gian Maria Milesi-Ferretti; Assaf Razin
Abstract: This paper studies sharp reductions in current account deficits and large exchange rate depreciations in low- and middle-income countries. It examines which factors help predict the occurrence of a reversal or a currency crisis, and how these events affect macroeconomic performance. It finds that both domestic factors, such as the low reserves, and external factors, such as unfavourable terms of trade and high interest rates in industrial countries, trigger reversals and currency crises. The two types of events are, however, distinct; indeed, current account imbalances are not sharply reduced in the years following a currency crisis. Economic performance around these events is also quite different. An exchange rate crash is associated with a fall in output growth and a recovery thereafter, while for reversal events there is no systematic evidence of a growth slowdown.
Keywords: currency crisis; current account reversal; growth; real exchange rate; openness
JEL Codes: F31; F32; F33; F34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low reserves (Q30) | current account reversals (F32) |
| unfavorable terms of trade (F14) | current account reversals (F32) |
| currency crises (F31) | decline in output growth (O49) |
| current account reversals (F32) | decline in growth (O49) |
| high investment rates (G31) | current account reversals (F32) |