Withstanding financial crises: would trade partners help or hurt?

Abstract

ABSTARCTThis article provides new empirical evidence on the losses of real activity caused by various financial shocks. Spillover effects due to foreign trade linkages deserve special attention. To this end, we estimate a modify auto-regressive process and a Seemingly Unrelated Regression Equations estimator is used to account for the dependency of one’s country growth on its trade-weighted partners growth. We run estimations on a set of currency collapses, banking crises and sovereign defaults in 49 advanced and developing countries from 1978 to 2011. The trade-weighted foreign demand effect mitigated the economic downturn following a banking or a sovereign debt crisis in all countries, while only the advanced ones benefited from it after a currency collapse. Trade-based spillover effects make banking crises more costly in the developing countries, in those that liberalize their financial account. It contrasts with what is observed during currency or sovereign debt crises.