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Modeling the Global Effects of the COVID-19 Sudden Stop in Capital Flows

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Abstract

The COVID-19 outbreak has triggered unusually fast outflows of dollar funding from emerging market economies (EMEs). These outflows are known as “sudden stop” episodes, and they are typically followed by economic contractions. In this post, we assess the macroeconomic effects of the COVID-induced sudden stop of capital flows to EMEs, using our open-economy DSGE model. Unlike existing frameworks, such as the Federal Reserve Board’s SIGMA model, our model features both domestic and international financial constraints, making it well-suited to capture the effects of an outflow of dollar funding. The model predicts output losses in EMEs due in part to the adverse effect of local currency depreciation on private-sector balance sheets with dollar debts. The financial stresses in EMEs, in turn, spill back to the U.S. economy, through both trade and financial channels. The model-predicted output losses are persistent (consistent with previous sudden stop episodes), with financial effects being a significant drag on the recovery. We stress that we are only tracing out the effects of one particular channel (the stop of capital flows and its associated effect on funding costs) and not the totality of COVID-related effects.

Suggested Citation

  • Ozge Akinci & Gianluca Benigno & Albert Queraltó, 2020. "Modeling the Global Effects of the COVID-19 Sudden Stop in Capital Flows," Liberty Street Economics 20200518, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednls:87990
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    Cited by:

    1. Lucjan T. Orlowski, 2021. "The 2020 Pandemic: Economic repercussions and policy responses," Review of Financial Economics, John Wiley & Sons, vol. 39(1), pages 20-26, January.
    2. Allan Webster & Sangeeta Khorana & Francesco Pastore, 2021. "The labour market impact of COVID-19: early evidence for a sample of enterprises from Southern Europe," International Journal of Manpower, Emerald Group Publishing Limited, vol. 43(4), pages 1054-1082, November.
    3. Davis, J. Scott & Zlate, Andrei, 2023. "The global financial cycle and capital flows during the COVID-19 pandemic," European Economic Review, Elsevier, vol. 156(C).

    More about this item

    Keywords

    sudden stops; COVID-19; spillovers and spillbacks;
    All these keywords.

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • F1 - International Economics - - Trade

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