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

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.