Crisis in Turkey: Estimating the Potential Welfare Loss?

While large and persistent current account deficit and external debt stock are among the most common causes of economic crises, measuring the risk associated with them is not easy. The literature typically focuses on the total external debt stock and the size of the current account deficit, which provide limited information. This study proposes a more accurate risk index by measuring the real size of the external debt stock and considering how external resources are utilized. Once external borrowing becomes a significant risk factor, a painful adjustment process starts in the form of slow growth or a crisis. Our index measures the extent of risk and the potential cost of the adjustment process. We empirically test the accuracy of our index by using the experiences of a number of selected countries affected by the 2008 crisis and show that the index can explain 77% of the variation in real consumption in those countries. By using the empirical results, we also estimate the potential cost that Turkey might experience once the currency crisis develops into a full-blown crisis.