Financial Crises and Economic Growth - A Long Run Perspective

Yaroslava Babych

No 003-11, Working Papers from International School of Economics at TSU, Tbilisi, Republic of Georgia

Abstract: In the economic literature the costs of financial crises are typically defined as cumulative output losses until the resolution of the crisis. Given this definition, majority of the empirical studies have documented significant economic costs associated with currency, banking and the twin crises. Few studies, however, looked at the long-term effect of various types of crises. In this paper I estimate the effect of currency, banking and twin crises episodes on the probability of initiating the periods of prolonged and significant growth spurs and downturns – the growth take-offs, and the growth collapses. I find that currency crises are significant positive predictors of growth take-offs, especially in the post World War II period. The currency crises episodes, however, were reducing the probability of growth take-offs during the Gold Standard era. I also find that the average export growth in the five years following a currency crisis was 5.6% above the historical mean in post-World War II years, whereas during the Gold Standard era, the corresponding deviation of export growth from the mean was not statistically different from zero. This may be interpreted as the evidence in favor of the hypothesis that the "resumption rule" of the Gold Standard era – the implicit rule prescribing a prompt return to of the original parity with gold following a currency crisis - may have contributed to the overvaluation of the real exchange rate and dampening of the economic activity in the long run. The results of the paper confirm the intuition that twin crises are likely to significantly dampen economic activity even in the long run. Twin crises are found to be positive predictors of growth collapses during 1980-2003, and negatively influencing the probability of growth take-offs during the Gold Standard years.

Pages: 41 pages
Date: 2011-09
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