Reserves, Capital Flows, and Crisis: Empirical Determinants of the Great Recession’s Effect on National Output

Abstract

Using a dataset of 138 countries, this paper seeks to provide a better understanding of the relationship between reserve accumulation, different types of capital flows, and output performance during the global financial recession of 2008-2009. It presents three main findings. First, empirical evidence shows that national savings is a robust indicator of a nation’s foreign exchange reserve holdings, and including it as an explanatory variable in the financial stability model brings us slightly closer to solving the reserve accumulation puzzle. Second, while short-term debt is an ineffective indicator of international reserve holdings, data shows that it is in fact an effective predictor of a country’s short-term GDP growth performance during the Great Recession. Finally, countries with higher levels of financial activity prior to the crisis suffered greater declines in GDP growth rate, but only because the declines are compared to unusually high growth rates in the boom prior to the crisis. When assessing crisis severity in terms of real output, or when taking a longer-run perspective on the crisis severity measure, higher capital flow activity may be perceived as a positive indicator of national output performance