My Ford Scholars project this summer was focused on the effects of different types of financial crises (systemic banking, exchange rate and sovereign debt crises) on sectoral value added and employment. Even though a large amount of literature has been dedicated to exploring the impact of crises on the overall level of output, only few papers research the changes in the individual sectors. In this context, the paper “The Cost of Financial Crises: A Sectoral Analysis” provides a relevant contribution to the existing literature by estimating the magnitude of the effect of crises on agriculture, industry and services.

Working with Professor Islamaj, we collected data on sectoral value added and employment from the World Bank and the Groningen Growth and Development Center database and used Stata (a statistical software) to perform analysis on the effect of the occurrence of crises episodes in both emerging markets and developing economies. The data on crises is obtained from three main data sources – Levi-Yeyatti and Panizza, Leavan and Valencia, and Reinhart and Rogoff. The preliminary research showed evidence that banking crises lead to longer recoveries in sectors heavily dependent on external finance. Furthermore, exchange rate crises do not have as severe effect on sectors that are primarily export-oriented because currency depreciation increases firms’ competitiveness. Our results are consistent with these hypotheses.

Another method of determining the differences in the cost of financial crises across sectors is by looking at the duration and amplitude of the sectoral “episodes”, where duration is defined as the time period during which sectoral value added decreases and similarly, amplitude is defined as the change in value added in the year following the occurrence of a crises. The two tables below show our findings. The industrial sector is more severely affected by debt and banking crises, with drop in output lasting 0.588 and 0.524 years on average. However, the results for amplitude show a larger negative impact of banking crises compared to debt crises (1.47% and 0.55% respectively). In addition, banking crises leads to an increase in the value added of agriculture and a decrease in the service sector. Interestingly, value added in the three sectors increases after the occurrence of a currency crises.

Table 1: Crises Duration

Table 2: Crises Amplitude

My involvement in the project consisted primarily of carrying out a literature review on previous papers researching similar and related topics, obtaining and organizing data, and writing do-files (text files containing commands to be executed by the statistical software Stata).