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Currency Crises, Capital Account Liberalization, and Selection Bias

  • Glick, Reuven
  • Guo, Xueyan
  • Hutchison, Michael M.

Are countries with unregulated capital flows more vulnerable to currency crises? Efforts to answer this question properly must control for “self selection†bias since countries with liberalized capital accounts may also have more sound economic policies and institutions that make them less likely to experience crises. We employ a matching and propensity score methodology to address this issue in a panel analysis of developing countries. Our results suggest that, after controlling for sample selection bias, countries with liberalized capital accounts experience a lower likelihood of currency crises. That is, when two countries have the same likelihood of allowing free movement of capital (based on historical evidence and a very similar set of economic and political characteristics)—and one country imposes controls and the other does not-- the country without controls has a lower likelihood of experiencing a currency crisis. This result is at odds with the conventional wisdom and suggests that the benefits of capital market liberalization for external stability are substantial.

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Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt12t6x2ht.

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Date of creation: 01 Jun 2004
Date of revision:
Handle: RePEc:cdl:ucscec:qt12t6x2ht
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  1. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
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  8. Leonardo Bartolini & Allan Drazen, 1996. "When liberal policies reflect external shocks, what do we learn?," Staff Reports 18, Federal Reserve Bank of New York.
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  10. De Gregorio, Jose & Edwards, Sebastian & Valdes, Rodrigo O., 2000. "Controls on capital inflows: do they work?," Journal of Development Economics, Elsevier, vol. 63(1), pages 59-83, October.
  11. Vittorio Grilli & Gian-Maria Milesi-Ferretti, 1995. "Economic Effects and Structural Determinants of Capital Controls," IMF Working Papers 95/31, International Monetary Fund.
  12. Easterly, William & Levine, Ross, 1997. "Africa's Growth Tragedy: Policies and Ethnic Divisions," The Quarterly Journal of Economics, MIT Press, vol. 112(4), pages 1203-50, November.
  13. Pierre-Olivier Gourinchas & Olivier Jeanne, 2004. "The Elusive Gains from International Financial Integration," IMF Working Papers 04/74, International Monetary Fund.
  14. Sebastian Edwards, 1999. "Crisis Prevention: Lessons from Mexico and East Asia," NBER Working Papers 7233, National Bureau of Economic Research, Inc.
  15. Hali J. Edison & Michael W. Klein & Luca Ricci & Torsten Sloek, 2002. "Capital Account Liberalization and Economic Performance: Survey and Synthesis," NBER Working Papers 9100, National Bureau of Economic Research, Inc.
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  17. Bartolini, Leonardo & Drazen, Allan, 1997. "Capital-Account Liberalization as a Signal," American Economic Review, American Economic Association, vol. 87(1), pages 138-54, March.
  18. Reinhart, Carmen & Edison, Hali, 2001. "Stopping hot money," MPRA Paper 13862, University Library of Munich, Germany.
  19. Heckman, James J & Ichimura, Hidehiko & Todd, Petra, 1998. "Matching as an Econometric Evaluation Estimator," Review of Economic Studies, Wiley Blackwell, vol. 65(2), pages 261-94, April.
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