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Fiscal and monetary policies and the cost of sudden stops

  • Hutchison, Michael M.
  • Noy, Ilan
  • Wang, Lidan

This article investigates the effects of monetary and fiscal policies on output growth during sudden-stop balance of payments crisis in emerging markets and developing countries. Sudden stops in capital flows, and subsequent deep recessions, are a frequent occurrence in these countries but there is no professional consensus, and little systematic empirical evidence, shedding light on the macroeconomic policy mix most likely to limit output losses during these episodes. To address this issue, we investigate 83 sudden-stop crisis in 66 countries using a baseline empirical model to control for the various determinants of output losses during sudden stops. We measure the marginal effects of policy on output losses, and find strong evidence that monetary tightening (rise in the discount rate or unsterilized rise in international reserves) and discretionary fiscal contraction are significantly correlated with larger output losses following a sudden stop. Fiscal expansion is associated with smaller output losses following a sudden stop, but monetary expansion has no discernable effect. The macroeconomic policy mix associated with the least output loss during a sudden-stop financial crisis is a discretionary fiscal expansion combined with a neutral monetary policy.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 29 (2010)
Issue (Month): 6 (October)
Pages: 973-987

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Handle: RePEc:eee:jimfin:v:29:y:2010:i:6:p:973-987
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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