country in question that had the most statistical power. Again, we are inclined to interpret this in terms of the growing importance of global factors.

Sudden stops have both financial and real effects. The financial effects show up first: the exchange rate depreciates, reserves decline, and equity prices fall. GDP growth then decelerates, investment slows, and the current account strengthens. The growth of GDP falls by roughly 4 percent year on year in the first four quarters of a sudden stop. The decline in GDP is somewhat larger in the second subperiod, reflecting a larger global shock (larger increase in the VIX, in particular), something whose effects were offset only partially by stronger macroeconomic positions.

In terms of policy responses, countries responded in the 1990s by stepping down the exchange rate, sometimes floating the currency, and then supporting that new exchange rate or float with a tighter monetary policy. In the worst-hit cases there was also resort to an IMF program, extension of which typically entailed trade reforms, fiscal tightening, and privatization of public enterprises. In the second subperiod, there was less of a tendency to tighten both monetary and fiscal policies. Indeed some countries were actually able to reduce policy interest rates as a way of supporting economic activity and financial markets. Less monetary stringency and some currency depreciation were feasible because countries had reduced foreign currency mismatches in the interim, limiting balance-sheet damage from depreciation. Budgets already being closer to balance (fiscal positions being stronger), countries were able to respond with less fiscal consolidation. Recourse to IMF programs was less frequent in the 2000s, partly because countries had accumulated international reserves and moved to more flexible exchange rates in the interim.

This is progress after a fashion. At the same time, it is clear that the recipe of stronger fiscal positions, more flexible exchange rates, deeper financial markets and less foreign currency mismatch has not insulated emerging markets from sudden stops; the frequency of the event has not declined over time. Any benefit from stronger country fundamentals has been offset by larger external shocks emanating from the rest of the world. Nor has progress on the policy front limited the negative output effects. As we show below, the drop in output in the first four quarters is no smaller in the second subperiod than the first; if anything it is slightly larger.<sup>5</sup> It would appear with the continued growth of international financial markets and transactions, countries are now exposed to larger capital flow reversals when foreign lending stops, and those larger reversals have more disruptive output effects. It is troubling that neither national officials, with the increased policy space, nor the international financial institutions, with their proliferation of new financing facilities, have succeeded in cushioning emerging markets from these effects.

# **2. Basics**

Our country sample is all emerging markets with their own currencies for which capital flow data are available for at least 24 consecutive quarters between 1991 and 2014. Our primary source of quarterly gross capital flow data is the International Monetary Fund’s International

> 5 Although the difference is not statistically significant at standard confidence levels.

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