Against the backdrop of the biggest financial crisis since the Great Depression, this chapter studies how financial stress in advanced economies is transmitted to emerging economies. Crises in advanced economies have a large common effect on the banking sectors, stock markets, and foreign exchange markets of emerging economies. There is also a sizable country-specific effect, which appears to be magnified by the intensity of financial linkages. In more normal times, reducing individual countries' vulnerabilities, such as current account and fiscal deficits, can lower the level of financial stress in emerging economies, but such improvements provide little insulation from the transmission of a major financial shock from the advanced economies. Given the current banking crises in advanced economies, reductions in banking flows to emerging economies could be large and long-lasting. The major negative spillovers and repercussions of this for both advanced and emerging economies argue for a coordinated policy response.
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