From the Great Moderation to the global crisis: Exchange market pressure in the 2000s

This paper investigates the factors explaining exchange market pressures (EMP) and thehoarding and use of international reserves (IR) by emerging markets during the 2000s, as the GreatModeration turned to the 2008-9 global crisis and great recession. According to our results, bothfinancial and trade factors played important roles, yet the relative magnitude of financial considerationsdominated, both during the Great Moderation and during the crisis. The coefficient of gross short-termexternal debt quintuples during the onset of the crisis, and then gradually declines as we let the crisiswindow roll forward. Capital outflow (induced by global deleveraging) was the force behind theemerging markets EMP rise during the global financial crisis, with the emerging markets’ stock marketsthemselves only playing a secondary role. In addition, emerging markets were greatly affected by thefall in commodity prices during the initial phase of the crisis, although the relative impact of tradefactors remained virtually the same in magnitude during the financial crisis and the Great Moderationperiod that preceded it. We also study the association between several country-level indicators, as of2007, and the EMP measure during the height of the crisis in 2008:Q4 in a cross sectional regression.We found that that richer EMs experienced greater EMP during the crisis. Greater FDI inflows prior tothe crisis were associated with a lower crisis EMP, while greater portfolio debt inflows with a highercrisis EMP, and this effect is much larger than the mitigation effect associated with greater FDI inflows.We conclude with an analysis of the factors that account for the trade and financial exposure ofemerging markets during the crisis, finding that pre-crisis financial and trade openness are significantpredictors of the financial and trade shock during the crisis. The severity of the financial shock wasfurther exacerbated by financial ties to the U.S., while the trade shock was more severe in EMs with alarger commodity export share.