Who's Afraid of a Sudden Stop?

The “sudden stop” – a sharp, catastrophic reversal from capital inflow to outflow – has become the bane of interdependent states in the global marketplace. Sudden stops wreak havoc on a country’s exchange rate and balance of payments and, if left unresolved, can force a government into accepting bailouts with politically unpalatable strings attached. Despite these risks, states continue seeking to attract internationally footloose capital into their domestic systems. This raises a key question: what makes an economy particularly vulnerable to the sudden stop phenomenon? By examining the division between creditors and debtors among relatively wealthy OECD states, this paper offers evidence that there are three risk factors that compound the dangers of importing capital: (a) a generally old population; (b) higher per-capita levels of income; and (c) allocations of domestic capital that prioritize credit to the banking and household sectors. The paper places special focus on the third of these risk factors, assessing the degree to which excessive non-productive credit formation can render a country vulnerable to a sudden stop and the attendant political and economic consequences.