Working Paper: NBER ID: w14026
Authors: Guillermo A. Calvo; Alejandro Izquierdo; Luis Fernando Mejía
Abstract: Using a sample of 110 developed and developing countries for the period 1990-2004 we analyze the empirical characteristics of systemic sudden stops (3S) in capital flows --understood as large and largely unexpected capital account contractions that occur in periods of systemic turmoil -- and the relevance of balance sheet effects in the likelihood of their materialization. We conjecture that large real exchange rate (RER) fluctuations come hand in hand with 3S. A small supply of tradable goods relative to their domestic absorption -- a proxy for potential changes in the real exchange rate -- and large foreign-exchange denominated debts towards the domestic banking system, denoted Domestic Liability Dollarization, DLD, are claimed to be key determinants of the probability of 3S, conforming a balance-sheet effect that impacts on the probability of 3S in non-linear fashion. Regarding financial integration, the larger is the latter, the larger is likely to be the probability of Sudden Stop; however, beyond a critical point the relationship gets a sign reversion.
Keywords: systemic sudden stops; balance sheet effects; financial integration; capital flows
JEL Codes: F31; F32; F34; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large fluctuations in the real exchange rate (RER) (F31) | probability of systemic sudden stops (3s) (P30) |
| domestic liability dollarization (DLD) (F34) | probability of systemic sudden stops (3s) (P30) |
| supply of tradable goods relative to domestic absorption (F16) | probability of systemic sudden stops (3s) (P30) |
| financial integration (F30) | probability of systemic sudden stops (3s) (P30) |
| financial integration (beyond a critical point) (F65) | probability of systemic sudden stops (3s) (P30) |