The Impact of Current Account Reversals on Growth in Central and Eastern Europe

According to economic theory, the capital inflows reversal – so-called sudden stop – has a significant negative effect on economic growth. This paper investigates the direct impact of current account reversals on growth in Central and Eastern European countries. Two steps to conduct the analysis are applied. In the first step the standard growth equation is estimated when including the current account reversal impulse dummy. I find that after a current account reversal the growth rate declines by 1.10 percentage points in the current year. The subsequent analysis of the adjustment dynamics builds upon the notion of convergence. The unconditional and conditional convergence coefficients are found to be - 0.47 and -0.52, respectively. This implies that the consequences of the reversal are likely eliminated after 3.3 years when the actual growth rate is back at its equilibrium level, ceteris paribus. Finally, the cumulative loss associated with a sudden stop in capital flows is about 2.3 percentage points. One may infer that Central and Eastern European countries are relatively flexible in terms of adjustment and reallocation of resources given the findings in similar literature examining either a more general sample or concentrating on rather different regions.