The relationship between currency crises and capital flow reversals: An empirical examination

Abstract

Large capital flow reversals and currency crises are an important feature of the global economy. They are often treated as being closely related and as typically occurring together. We investigate the relationship between them for a large set of emerging market economies using both event analysis and logit estimation. We find that more often than not the two types of events do not occur together. We find that this conclusion holds irrespective of the way in which currency crises and capital flow reversals are measured. We examine the circumstances under which we might expect them to occur together or separately and compare the behavior of a number of economic and financial variables prior to each type of event. While some conditions, such as rapid credit growth and economic overheating precede both currency crises and capital reversals, we also find important differences. Exchange rate behavior tends to be more important for currency crises than for capital flow reversals, while capital flow surges and financial conditions in the global economy are more important for capital flow reversals.