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Interest Premium, Sudden Stop, and Adjustment in a Small Open Economy

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  • Peter Benczur
  • Istvan Konya

Abstract

This article studies the adjustment process of a small open economy to a sudden worsening of external conditions. The sudden stop is modeled by the use of a highly nonlinear specification that captures credit constraints in a convenient way. The advantage of this approach is that the effects of the shock become highly conditional on the external debt position of the economy. A two-sector model with money-in-the-utility is adopted, thereby making it possible to study sectoral asymmetries in the adjustment process, and also the role of currency mismatch. The model is calibrated to the behavior of the Hungarian economy in the 2000s, and its crisis experience in 2008–11 in particular. Four counterfactuals are calculated: two with different exchange rate policies (a more flexible float and a perfect peg), and both of these policy regimes with smaller initial indebtedness. Overall, the model is able to fit the movements of key aggregate and sectoral macroeconomic variables after the crisis by producing a large and protracted deleveraging process. It also offers a meaningful quantification of the policy tradeoff between facilitating the real adjustment by letting the currency depreciate and protecting consumption expenditures by limiting the adverse effect of exchange rate movements on household balance sheets.

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  • Peter Benczur & Istvan Konya, 2016. "Interest Premium, Sudden Stop, and Adjustment in a Small Open Economy," Eastern European Economics, Taylor & Francis Journals, vol. 54(4), pages 271-295, July.
  • Handle: RePEc:mes:eaeuec:v:54:y:2016:i:4:p:271-295
    DOI: 10.1080/00128775.2016.1196109
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    Cited by:

    1. Kónya, István & Váry, Miklós, 2023. "Which Sectors Go On When There Is a Sudden Stop? An Empirical Analysis," Corvinus Economics Working Papers (CEWP) 2023/05, Corvinus University of Budapest.
    2. Brzoza-Brzezina, Michał & Kotłowski, Jacek, 2020. "The Nonlinear Nature Of Country Risk And Its Implications For Dsge Models," Macroeconomic Dynamics, Cambridge University Press, vol. 24(3), pages 601-628, April.

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    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance

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