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Output Costs of Currency Crisis and Banking Crisis: Shocks, Policies and Cycles

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Abstract

This paper studies output declines during currency crises based on the theoretical currency crisis model, highlighting the role of shocks that trigger crises. Using panel data on 49 developing countries, we find that both productivity shocks in the real sector and shocks to the country’s risk premium in financial markets affect the output costs of currency crises, which are 4% of GDP on average and 8% for severe crises. Output costs of banking crises are 6–7% of GDP. During severe currency crises in Asian and Latin-American countries, both productivity shocks and exchange rate overvaluation were found to be important factors in explaining large output losses.

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Notes

  1. Other types of third-generation models include moral hazard caused by government guarantees (McKinnon and Pill 1999; Corsetti et al. 1999; Dooley 2000; Dekle and Kletzer 2002; Burnside et al. 2004; Schneider and Tornell 2004, etc.), which is difficult to measure as a shock because it always takes several years for the overborrowing syndrome to result in a crisis.

  2. The number of sample countries decreased slightly from 51 in Nakatani (2017b) to 49 in this paper because we included an additional fiscal variable to control for the effects of fiscal policy on output.

  3. If a monthly real exchange rate variable is missing in this database, the data are taken from the Bank for International Settlement’s monthly real exchange rates.

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  1. International Monetary Fund, 700 19th Street, N.W., Washington, DC, 20431, USA

    Ryota Nakatani

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  1. Ryota Nakatani
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Correspondence to Ryota Nakatani.

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Nakatani, R. Output Costs of Currency Crisis and Banking Crisis: Shocks, Policies and Cycles. Comp Econ Stud 61, 83–102 (2019). https://doi.org/10.1057/s41294-018-0069-1

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