Current account reversals and growth: the direct effect Central and Eastern Europe 1923-2000

Abstract

According to economic theory, the capital inflows reversal - so called sudden stop - has a significant effect on economic growth. This paper investigates the direct impact of current account reversals on growth in Central and Eastern European countries. Two steps to conduct the analysis are applied. In the first step we estimate the standard growth equation augmented by an effect of the current account reversal. We find that after a current account reversal the growth rate declines by 1.10 percentage points in the current year. The subsequent analysis of the adjustment dynamics builds upon the notion of convergence. We find the unconditional and conditional convergence coefficients to be -0.47 and -0.52, respectively. This implies that the consequences of the reversal are likely eliminated after 3.3 years when the actual growth rate is back at its equilibrium level, ceteris paribus. Finally, the cumulative loss associated with a sudden stop in capital flows is about 2.3 percentage points. We infer that Central and Eastern European countries are relatively flexible in terms of adjustment and reallocation of resources given the findings in similar literature examining either a more general sample or concentrating on rather different regions