‘SUDDEN STOPS’: GROWTH IMPACT DEPENDS ON WHETHER IT’S GLOBAL OR LOCAL INVESTORS PUTTING THEIR MONEY ELSEWHERE

The impact of‘sudden stops’ – when the flow of capital into an economy dries up – depends on whether they are driven by the decisions of domestic residents to invest abroad or those of foreign residents to cut off funds. According to research by César Calderón and Megumi Kubota, the determinants of inflow- and outflow-driven sudden stops are quite different and so are their policy implications.

Sudden stops lead to lower investment, lower productivity and ultimately lower economic growth. Being able to distinguish the type of sudden stop and its causes will help policy-makers manage and prevent them. For example, since sudden stops are increasingly caused by domestic investors moving money out of the economy, the imposition of controls on inflows will not necessarily deter those outflows.

The research, presentedat the Royal Economic Society’s 2011 annual conference, analyses a wide range of data from developed and developing countries over the past 40 years. It finds that the decisions by both foreign and domestic investors are determined by the economic situation in their home countries.

Foreign investors are less likely to stop investing whenever their home economy is growing and the world interest rate is low. Domestic investors, on the other hand, are more willing to move their money abroad when local economic performance is poor, the financial system is weak and there are high levels of savings.

Rising financial openness makes a country more vulnerable to sudden stops caused by either local or global investors. But the effects of financial openness depend on the structure of foreign liabilities – that is, countries with higher shares of foreign direct investment are less prone to inflow-driven sudden stops whereas the opposite holds for outflow-driven sudden stops.

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This paper provides a more nuanced analysis of sudden stops by distinguishing between those sudden stops driven by lower gross inflows by foreign investors in the domestic economy from those attributed to larger gross outflows from domestic residents.

Hence, it aims at characterising the determinants of sudden stops driven by foreign vis-à-vis domestic residents. Whereas the former are determined by a positive growth outlook in the foreign investors’ own economy, the latter are determined by poor performance of the domestic economy, weak domestic financial systems or high external savings.

The researchers ask whether the decisions of domestic residents to invest abroad or those of foreign residents to cut off funds from the domestic economy are governed by the same set of determinants. This distinction has become more relevant in recent years with the high accumulation of savings by emerging markets – especially, emerging Asia and oil exporting nations – and with outflows of capital from their countries signalling a need for portfolio diversification rather than capital flight.

This paper argues that the determinants of the different types of sudden stops may not be alike given the differences in their distribution over time and their macroeconomic consequences.

Empirical research has typically identified sudden stops as episodes where net reversals of capital flows take place. But the observed decline in the financial account could be driven by decisions of either foreign investors (where foreign capital ceases to flow into the domestic economy) or local investors (where there are sudden increases in investors’ international investments).

Using a wide array of developed and developing countries from 1970 to 2007, the study first shows some stylised facts on the different types of sudden stops. The findings show that outflow-driven sudden stops have become a more common theme in the 2000s.

The distinction among types of sudden stops does matter for macroeconomic outcomes. A sharp reduction of foreign capital into the domestic economy puts an additional cost in terms of lower growth in real output and investment. In addition, growth in GDP per worker at the moment of sudden stops would be more severely affected if the sudden stops were caused by global residents reducing their inflows to the domestic economy. The same story holds for productivity growth.

The study also finds that global investors are less likely to stop bringing their capital whenever their economy is growing and the world interest rate is lower. Local residents, on the other hand, are more willing to invest abroad when macroeconomic performance is poor (high inflation), the financial system is weak, and there are high external savings (current account surpluses).

Rising financial openness makes the domestic country more vulnerable to sudden stops caused by either local or global investors. The effects of financial openness depend on the structure of foreign liabilities – that is, countries with higher shares of foreign direct investment are less prone to inflow-driven sudden stops whereas the opposite holds for outflow-driven sudden stops.

The authors’ final argument is that since determinants of inflow- and outflow-driven sudden stops are different, their policy implications are of course different. This implies that, for example, the imposition of controls on inflows may not necessarily deter the outflows of capital from domestic residents.

ENDS

‘Sudden Stops: Are Global and Local Investors Alike?’ by César Calderón and Megumi Kubota

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