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Policy Response to External Shocks: Lessons from the Crisis

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  • Carlos Capistrán
  • Gabriel Cuadra
  • Manuel Ramos Francia

Abstract

Emerging economies have been subject to abrupt reversals in capital inflows, which have adverse consequences for economic activity and financial stability. An important question for policymakers is how to respond to a sudden loss of external financing and its negative effects on the domestic economy. The experience of emerging economies through the recent financial crisis shows that those economies with relatively better economic fundamentals were able to implement countercyclical policies. This paper provides a simple analytical framework to rationalize this evidence. In particular, it addresses this issue by developing a small-scale macroeconomic model of the New Keynesian type. Numerical exercises illustrate how both credible monetary and fiscal policies increase policymakers’ degrees of freedom to respond to adverse external shocks.

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File URL: http://www.banxico.org.mx/publicaciones-y-discursos/publicaciones/documentos-de-investigacion/banxico/%7BFD549F38-8C64-28D2-EEC2-D9CD0209C7C0%7D.pdf
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Bibliographic Info

Paper provided by Banco de México in its series Working Papers with number 2011-14.

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Date of creation: Dec 2011
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Handle: RePEc:bdm:wpaper:2011-14

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Web page: http://www.banxico.org.mx
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Keywords: Reversals in capital flows; emerging economies; monetary policy; fiscal policy.;

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  1. Jordi Gali & Mark Gertler & David Lopez-Salido, 2005. "Robustness of the Estimates of the Hybrid New Keynesian Phillips Curve," NBER Working Papers 11788, National Bureau of Economic Research, Inc.
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  8. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
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  14. Cristina Arellano & Enrique G. Mendoza, 2002. "Credit Frictions and 'Sudden Stops' in Small Open Economies: An Equilibrium Business Cycle Framework for Emerging Markets Crises," NBER Working Papers 8880, National Bureau of Economic Research, Inc.
  15. Jeremy Rudd & Karl Whelan, 2006. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?," American Economic Review, American Economic Association, vol. 96(1), pages 303-320, March.
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