How Does Currency Mismatch Affect Resilience to an External Shock? Evidence From the 2007-2009 Global Financial Crisis
Fairl, Kathleen Ellen
In the aftermath of the 1990s global financial crises, excessive foreign currency borrowing emerged as the common denominator in predicting the likelihood of a crisis as well as an economy's capacity to withstand one. Expressed as the gap between foreign currency-denominated assets and liabilities, currency mismatch was shown to heighten foreign debt obligations in the event of a large devaluation, thereby triggering default, bankruptcies, and deep output contractions. Using panel data for 18 emerging economies from 1998-2011, this study estimates the contribution of currency mismatches to the behavior of real GDP growth before and during the recent 2007-2009 global financial crisis using country and year-level fixed effects. The main findings of the analysis suggest that increases in currency mismatch during the crises are associated with increases in real GDP growth. The paper also finds that for countries operating under a flexible exchange rate regime, changes in currency mismatch are associated with increases in economic growth.
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