There are two articles in IMF’s F&D March 2010 issue which points to the importance of financial linkages in the crisis. The first shows how financial linkages mattered more than other factors. The second shows which region’s financial linkage mattered more.
In the first article:
To examine why some countries did better than others, we focused on revisions in gross domestic product (GDP) growth forecasts before and after the crisis for a sample of 40 emerging market countries and for a larger sample of 126 developing countries (which included emerging markets). We then assessed the importance of a wide range of factors that could explain differences in the size of these forecast revisions.
Growth forecast revisions for 2009 range from –18 percent to –1.5 percent, with the largest growth collapse occurring in eastern European and central Asian countries; the effects in Latin America were much more contained (see Chart 1). Our analysis suggests that countries with more leveraged domestic financial systems and more rapid growth in lending to the private sector tended to suffer larger downward revisions to their growth outlook. Exchange rate flexibility clearly helped buffer the impact of the shock, as countries with pegged exchange rate regimes fared significantly worse.
Trade channel impacts but not via the usually thought openness channel (i.e. countries which are more open to trade, decline more). Infact trade channel impacts via the composition of trade. And then the financial linkages impact via trade finance.
Interestingly, the trade channel appears to matter in this sample, although not for emerging markets. Although the degree of trade openness does not appear to be decisive, the composition of trade does make a significant difference. In particular, the share of commodities (both food and overall) in total exports is associated with smaller downward growth revisions. The share of manufacturing products in total exports is correlated with worse growth performance for all developing countries, a relationship already noted in the IMF’s Regional Economic Outlook: Asia and Pacific (2009). This is consistent with the notion that countries exporting manufacturing goods to advanced economies seem to have been hit hard by the decline in demand from these markets, while countries exporting food appear to have fared better.
More generally, the results are in line with the notion that the transmission of shocks to countries with lower financial linkages to the world (such as low-income economies) tend to occur predominantly through trade, whereas the financial channel is more relevant for countries with close financial ties to the advanced economies, where the crisis originated. Clearly trade finance, which declined sharply at the end of 2008, was a financial channel that affected nearly all economies—advanced, emerging market, and developing.
In the second article,
THE recent global crisis—the deepest and most widespread since the 1930s by any measure—has refocused attention on spillovers across countries. Did the size and nature of financial problems lead to a synchronized global downturn? Put another way, if we had anticipated the large U.S. (and U.K.) financial meltdown before the crisis, would we have predicted a synchronized global slowdown? There are good reasons to answer this question with a firm “yes.”
Our findings help explain the global nature of the boom over the 2000s and the severity of the ensuing global downturn. A series of positive shocks in the U.S. and U.K./global markets drove a global financial boom whose spillovers boosted growth in all major advanced economies. But that boom sowed the seeds of its own destruction, including through a synchronized set of commodity price hikes. When the financial excesses in the U.S. housing market started to deflate in late 2007, followed soon after by the U.K. housing market and global financial strains, these shocks eventually pulled down the advanced economies despite massive monetary and fiscal intervention. This confirms our premise that financial linkages are important and that financial shocks emanating from the United States and the United Kingdom have a major impact on the rest of the global economy.
What is interesting is how linkages and spillovers differ across regions. A shock in US and UK has maximum (-)ve impact and grows over time. EU has initial (-)ve impact but declines and becomes insignificant in some time. Japanese spillovers are insignificant. In rest of the world, a +ve shock leads to lower activity in other regions. Read the article for details.
Great insights. IMF research is on a roll.