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Our general goal in this paper is to understand the cross-country variation in the macroeconomic impact of the global financial crisis of 2008 and 2009. In particular, we aim to identify initial conditions that may help to explain the differential response of output and demand in different countries and regions to the global shock, with a special emphasis on financial factors, both domestic and cross-border. The standard narrative of the transmission of the global financial crisis emphasizes the role played by international financial linkages. The original shock in the U.S. financial system led to disruption in the financial systems of several advanced European countries and others around the world. In turn, the disruption in the financial system gradually transmitted to the real economy, with the financial crisis inducing a contraction in economic activity and remarkable declines in international trade and international capital flows in late 2008 and early 2009.
Although the scale of the crisis was clearly missed by most commentators, its transmission across countries seems easier to understand with the benefit of hindsight. The most affected countries--particularly those that had to rely on official external support--had severe asset price bubbles, large financial sector exposures, and/or heavy reliance on external capital flows because of large current account deficits. Yet the empirical work by Rose and Spiegel (2010a and 2010b) indicates that it is very difficult to understand the cross-country variation in the depth of the crisis if we focus on variables measuring cross-border trade and financial linkages. More generally, these authors fail to find any precrisis variable that is a robust correlate of the decline in growth since the onset of the crisis, in contrast with the "impressionistic" view sketched above.
In our empirical work we revisit the question of whether the cross-country incidence and severity of the crisis is systematically related to precrisis macroeconomic and financial factors, and argue that the evidence supports at least in part the "impressionistic view" that precrisis variables are helpful in understanding the intensity of the crisis. We focus on the impact of the crisis on the level of economic activity, rather than on the cross-country variation in the scale of the decline in asset prices or financial flows. In addition to examining differences in output growth across countries,...