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The output effect of gross foreign investment reversals

Thorsten Janus () and Daniel Riera-Crichton ()

Oxford Economic Papers, 2015, vol. 67, issue 2, 356-379

Abstract: A large literature links currency crashes and reversals in a country’s net external borrowing to output losses. In this article, we find that contractions in the stock of gross foreign claims on a country—a phenomenon we call gross foreign investment reversals (GIRs)—are also associated with output declines. GIRs are specially harmful during currency, current account, and sudden stop crises in emerging markets. Instrumental variables estimation suggests that this relationship is causal, running from GIR to output. Meanwhile, financial development and stocks of foreign assets can buffer emerging markets against the negative output effects of GIR. Jointly these findings suggest that changes in the composition of the current account, and not just its level or rate of change, can have first-order output effects. Thus, it may be important for future research to identify the determinants of GIR, a subject we only briefly touch on.

Date: 2015
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