Assessing the Impact of Episodes on the Financial Sector in Developing Economies: the role of Institutional Quality using Local Projection Framework

Abstract

Using local projections regression, we investigate the role of institutional quality in establishing the impact of the surge, stop flight, and retrenchment on the financial sector indicators such as inflation rate, interest rate, and domestic credit to private sector. The study considers 47 developing economies over the period 1980–2018. We find that both the liability flow-driven episode surges and asset flow-driven flight have a more strong influence on the financial sectors of the developing economies as compared to stop and retrenchment. In particular, we find that the level of institutional quality acts as a gatekeeper in the host economy. We conclude that the countries with a higher level of institutional quality are less prone to the negative impacts of the large episodes as compared to the countries with a low level of institutional quality.

JEL Classifications: C21; F21; O43&nbsp&nbsp

Keywords: Capital flows; Episodes; Institutions