Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality

50 Pages Posted: 10 Sep 2004

See all articles by Jeffrey A. Frankel

Jeffrey A. Frankel

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Eduardo A. Cavallo

Inter-American Development Bank (IDB) - Research Department

Multiple version iconThere are 2 versions of this paper

Date Written: August 2004

Abstract

Openness to trade is one factor that has been identified as determining whether a country is prone to sudden stops in capital inflow, currency crashes, or severe recessions. Some believe that openness raises vulnerability to foreign shocks, while others believe that it makes adjustment to crises less painful. Several authors have offered empirical evidence that having a large tradable sector reduces the contraction necessary to adjust to a given cut-off in funding. This would help explain lower vulnerability to crises in Asia than in Latin America. Such studies may, however, be subject to the problem that trade is endogenous. We use the gravity instrument for trade openness, which is constructed from geographical determinants of bilateral trade. We find that openness indeed makes countries less vulnerable, both to severe sudden stops and currency crashes, and that the relationship is even stronger when correcting for the endogeneity of trade.

Keywords: Economics - International Economics, Economics - Macroeconomics, International Trade and Finance

Suggested Citation

Frankel, Jeffrey A. and Cavallo, Eduardo A., Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality (August 2004). KSG Working Paper No. RWP04-038. Available at SSRN: https://ssrn.com/abstract=588961 or http://dx.doi.org/10.2139/ssrn.588961

Jeffrey A. Frankel (Contact Author)

Harvard University - Harvard Kennedy School (HKS) ( email )

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HOME PAGE: http://www.ksg.harvard.edu/fs/jfrankel

National Bureau of Economic Research (NBER)

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Eduardo A. Cavallo

Inter-American Development Bank (IDB) - Research Department ( email )

1300 New York Ave., NW
Washington, DC 20577
United States

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