Indirect and Compounded Effects of External Crises on Growth in Emerging Markets

An attempt to quantify possible negative effects of external crises in emerging market economies is made in this paper. The direct and indirect effects of the external crises, here sudden stops in capital flows and currency crises, are estimated and compounded into composite overall effects. In addition, an alternative approach for the analysis of the dynamics is introduced. I find that a current account reversal has a negative effect, both direct and indirect, on economic growth introducing a slowdown exceeding two percentage points in the current year. On the other hand, the direct effect of currency crises is insignificant and unlike in the case of the reversal the indirect effect dominates and delivers a negative overall effect of 1.8 percentage points. The time necessary for the adjustment of actual growth back to its equilibrium rate is roughly 1.8 years after the current account reversal and 1.6 years after the currency crisis. The corresponding cumulative losses are four and 3.3 percentage points for the reversal and the currency crisis, respectively.