Do International Capital Flows Worsen Macroeconomic Volatility in Transition Economies?
The 2008 financial crisis helped precipitate a near crisis in the transition economies of Central and Eastern Europe, which ultimately resulted in severe output declines throughout the region. What share of the responsibility did capital movements, particularly “hot money” flows, play in the rapid growth and subsequent recession in the periphery of the European Union? To answer this question, we examine the responses of output, consumption, and investment variability to shocks to both Foreign Direct Investment and non-FDI flows, using quarterly data from the mid-1990s to 2010. Impulse-response and variance decomposition analysis shows that “hot” non-FDI flows contribute more to macroeconomic volatility than do more stable FDI flows, and that certain countries, particularly those with fixed exchange rates, seem to be more vulnerable to shocks than others.
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