- Does Openness to Trade Make Countries Less Vulnerable to Sudden Stops? Using Gravity to Establish Causality
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- by Frankel, Jeffrey; Cavallo, Domingo
- 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.
- Publication Type: WCFIA Working Paper
- Published Date: December 2004
- Field of Interest: International Economics
- Frankel, Jeffrey, and Eduardo Cavallo. "Does Openness to Trade Make Countries Less Vulnerable to Sudden Stops? Using Gravity to Establish Causality." Working Paper 2008-0032, Weatherhead Center for International Affairs, Harvard University, August 16, 2004.
- Also NBER Working Paper No. 10957.