Impact of Financial Crisis on International Trade Essay Example for Free

Impact of Financial Crisis on International Trade EssayThe work described in this paper was substantially software documentationed by a grant from the Research Grant Council of the Hong Kong Special Administrative Region, China (Project no. HKUST6212/00H). 253 254 Zihui Ma and Leonard K. Cheng Forbes (2001) went further to occasion some statistics measuring the importance of trade linkages in transmittance crises. Because most economists agree that international trade is one of the important factors in explaining ? nancial crises, it calculates natural and crystal clear to ask the reverse hesitation what are the e? ects of ? nancial crises on international trade?Surprisingly, little research on this subject has been done. Perhaps the reason is that the dish appears to be obvious. Conventional wisdom would predict that a ? nancial crisis, by bringing about a recession in the macro thrift, would lead to a drop in imports. Exports, however, may rise because of both a decline in domestic demand and a devaluation of the domestic currency. A weakening or collapse of the ? nancial system, in particular the asserting system, however, might weaken the unpolisheds export capability. So the aggregate e? ects of a ? nancial crisis on the macroeconomy are unclear.This paper tries to ascertain whether the equivocalness can be resolved empirically. We divide all the past ? nancial crises into cardinal types banking crises and currency crises. These two di? erent types of crises had di? erent attributes and di? erent e? ects on international trade. This paper begins by analyzing theoretically the e? ects of banking and currency crises on international trade. Then it uses zygomorphous trade data, macroeconomic data, and geographic data to test the theoretical predictions. Overall, the empirical results provide support for the theoretical predictions.This paper contributes to the literature in two ways. First, it provides a theoretical manikin for understanding t he impact of ? nancial crises on international trade and the channels of crises transmittal through trade. Second, it estimates the e? ects of banking crises and currency crises on imports and exports. The estimated results can be employ to predict the impact of ? nancial crises on trade, thus providing useful information for risk precaution to policymakers. The remainder of the paper is organized as follows. Section 8. 2 reviews previous works on the relationship amid international trade and ? ancial crisis. Sections 8. 3 and 8. 4 analyze the e? ects of banking crises and of currency crises on trade, respectively. Section 8. 5 describes the data and methods used to estimate the e? ects of these crises. Section 8. 6 reports the results of empirical estimation and statistical testing. Section 8. 7 concludes. 8. 2 Literature Review Trade and Financial Crises Economists pay attention to the role played by trade in ? nancial crises for two reasons. First, trade imbalance has been sh own to be one of the important factors that trigger ? nancial crises. Current de? cits may decrease foreign reserves.As Krugman (1979) pointed out, a currency crisis is more apt(predicate) to happen in an economy that does non have enough foreign reserves. The E? ects of Financial Crises on International Trade 255 Second, ? nancial crises may be transmit through trade linkages from an a? ected country to others despite the latters relatively good fundamentals. In explaining such contagion e? ects, economists have act to identify the channels through which contagion was spread. As trade is the most obvious economic linkage between countries, much research has been devoted to this connection. piece the importance of trade imbalance in triggering crises is widely accepted, at that place is no agreement on the importance of trade in transmitting ? nancial crises. Eichengreen and Rose (1999) used a binary-probit model to test whether bilateral trade linkages transmitted crises betwe en industrial countries between 1959 and 1993. They found that the probability of a ? nancial crisis occurring in a country increased signi? cantly if the country had high bilateral trade linkages with countries in crises. They concluded that trade was an important factor.Glick and Rose (1999) conducted a similar analysis with more countries between 1971 and 1997 and obtained a similar result. Forbes (2000) used a companys stock market data to study the importance of trade in ? nancial crises transmission, and his result similarly showed that trade played an important role. However, other papers have provided di? erent answers to the problem. For instance, Baig and Goldfajn (1998) thought that trade linkage was unimportant in the East Asian Crisis because the direct bilateral trade batchs between these economies were very small.Masson (1998), analyzing the Mexican crisis and the Asian crisis, obtained similar results. All the papers that analyzed the relationship between trade and ? nancial crises ignored the reverse question how did ? nancial crises a? ect international trade? We argue that the e? ects of ? nancial crises on trade are a precondition for discussing whether trade transmits crises. If ? nancial crises do not a? ect countries imports and exports at all, how can ? nancial crises be transmitted through the trade channel? So before we analyze the importance of trade in transmitting ? ancial crises, we need to clarify the e? ects of ? nancial crises on international trade. As pointed out previously, little work has been done on this topic to date. It seems there is a impression that ? nancial crises only a? ect countries imports and exports through changes in the exchange rates. Because the e? ects of exchange rates have already been thoroughly analyzed before, it may seem that there is no need to study the question. However, this view may not be correct. A devaluation of a national currency will increase the volume of exports and reduce the volume of imports.Classic international trade theory shows that a devaluation improves the trade balance if the Marshall-Lerner condition is satis? ed. Because in a ? nancial crisis a country unremarkably experienced a devaluation of its national currency, the same analysis would apply, that is, the a? ected countries imports will decrease, but their exports will increase after the crises. Furthermore, ? nancial crises (including currency crises, banking crises, 256 Zihui Ma and Leonard K. Cheng or both) could withal a? ect trade through channels besides the exchange rate.Calvo and Reinhart (1999) pointed out that ? nancial crises usually caused capital account reversal (sudden stop) and triggered an economic recession. Mendoza (2001) showed that in an economy with imperfect credit markets these sudden stops could be an equilibrium outcome. The economic recession reduces not only domestic demand but also entireness output and export capability, whereas capital out? ow forces the countr y to increase export. Thus, whether exports increase or decrease after ? nancial crises is unclear without further analysis. Before we analyze how ? nancial crises a? ct the crisis countries imports and exports, let us ? rst de? ne ? nancial crises. Eichengreen and Bordo (2002) have provided de? nitions of currency crises and banking crises For an episode to qualify as a currency crisis, we mustiness observe a labored change in parity, abandonment of a pegged exchange rate, or an international rescue. For an episode to qualify as a banking crisis, we must observe either bank runs, widespread bank failures and suspension of convertibility of deposits into currency such that the latter circulates at a premium relative to deposits (a banking panic), or signi? ant banking sector problems (including but not limited to bank failures) resulting in the erosion of most or all of banking system collateral that are resolved by a ? scally-underwritten bank restructuring. (1516) The supra de? nitions are adopted in this paper. In the next two sections, we analyze the e? ects of banking crises and currency crises on the macroeconomy and trade. 8. 3 Impact of Banking Crises A classical framework of bank runs was developed by Diamond and Dybvig (1983). Let us recapitulate the key elements of their model. Agents are endowed with goods that can be invested in a long-run project or stored without costs.The long-term project is pro? table but illiquid, that is, if investors do not liquidate the project before it matures, its return is greater than the initial investment however, if the project is liquidated before it matures, the ? re-sale return is less than the initial investment. Each constituent can be impatient or patient with ? xed probabilities, but there is no aggregate uncertainty, that is, the total number of impatient agents is ? xed and known by all agents. At the beginning, agents do not know their own types but must decide if they will invest in the project.Afte r they have invested (or have decided not to invest), but before the project matures, each agent realizes his or her own type. Impatient agents must consume immediately, whereas patient agents do not consume anything until the project matures. Agents types are private information, so even if each agent knows his or her own type, other people do not know. The E? ects of Financial Crises on International Trade 257 On the one hand, if an agent does not invest in the project but turns out to be patient, then the agent has missed a pro? table investment opportunity.