In the Cem Çakmakl et al (2020) NBER working paper, the authors set forth a model outlining the macroeconomic effects of the Covid-19 outbreak. The model is interesting in that it integrates domestic and foreign supply and demand dynamics, notably taking international sectoral linkages into account through an input-output analysis. I will not focus on this though, as I wish to bring to centre stage another aspect of the paper: its contribution to the recent COVID-19-related research agenda which focuses on ‘Emerging Markets’ (EM) and their idiosyncrasies when faced with the challenges of the current crisis (the paper uses Turkey as a case study).
How are emerging markets (EMs) different from developed countries in their reaction to the COVID-19 crisis?
It is a consensus that governments must act to reduce the health and economic impacts of the pandemic. In advanced economies, sizable fiscal stimulus packages have been designed and are to be funded mostly through monetary financing, mainly QE and debt issuance. Stimuli have also been announced in non-developed economies but at a much lower level than at richer peers.
The underlying reason is that, on average, the less developed a country is, the more limited its fiscal space and general room for manoeuvre. The authors argue that it is much harder for EMs to rely on QE (or alternative monetary financing) as the enlargement of their central banks’ balance sheets may feed into credibility issues, rising inflation and sharp currency depreciation.
Furthermore, the authors highlight the importance of external funding for developing economies, which is also central to their post-pandemic economic recovery. Since the crisis hit, capital outflows from ‘exotic countries’ have been extremely large (in March, the Institute of International Finance’s Capital Flows Tracker registered the largest historical portfolio outflows from EM, above US$80 billion) and the risk premia of EM assets have significantly increased. Consequently, EM liquidity shortage risks have risen alongside difficulties to rollover their external debt.
Therefore, many EMs will need to undertake a number of measures, to prevent such a liquidity crisis and support the domestic economy. In this regard, the authors outline a set of different policy alternatives; from swap agreements with reserve countries/institutions and FX agreements with international institutions to capital controls and debt memorandums. They also highlight problems and shortcomings associated with such alternatives.
Conclusion
The NBER working paper is an interesting piece both with respect to its modelling assumptions and results - especially with regard to the indirect effects of the pandemic through supply chain linkages - as well its insights on the differences between developed and developing country responses to the COVID-19 crisis. Although a ‘solution’ to the challenges faced by such economies is not yet clear, by bringing EMs to the centre stage, the paper helps to shed light into the matter.
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