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Monetary Policy under Sudden Stops

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  • Vasco Cúrdia

    (Princeton University)

Abstract

Emerging markets are often exposed to sudden stops of capital inflows. What are the effects of monetary policy in such an environment? To answer this question, the paper proposes a model with the typical elements of an emerging market economy. Credit frictions generate balance sheet effects, debt is denominated in foreign currency, production requires an imported input, and households have access to the international capital market only indirectly, through their ownership of leveraged firms. In the model, a sudden stop is generated by a change in the perceptions of foreign lenders, which leads to an increase in the cost of borrowing. The paper then compares the response of the economy to a sudden stop under alternative monetary policy rules. A first result is that the recession is most acute in a fixed exchange rate regime. Taylor rules reacting to inflation and output are more stabilizing. The comparison of policies also suggests that, rather than focus on whether to increase or decrease interest rates, it is more important to influence agents' expectations about future monetary policy. Furthermore, the flexible price equilibrium is attained if the monetary policy is set to completely stabilize the domestic price index.

Suggested Citation

  • Vasco Cúrdia, 2005. "Monetary Policy under Sudden Stops," International Finance 0510025, University Library of Munich, Germany, revised 19 Dec 2005.
  • Handle: RePEc:wpa:wuwpif:0510025
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    Cited by:

    1. Selim Elekdag & Mr. Harun Alp, 2011. "The Role of Monetary Policy in Turkey During the Global Financial Crisis," IMF Working Papers 2011/150, International Monetary Fund.
    2. Batini, Nicoletta & Gabriel, Vasco & Levine, Paul, 2010. "A Floating versus managed exchange rate regime in a DSGE model of India," Working Papers 10/70, National Institute of Public Finance and Policy.
    3. Andrea Ferrero & Mark Gertler & Lars E. O. Svensson, 2007. "Current Account Dynamics and Monetary Policy," NBER Chapters, in: International Dimensions of Monetary Policy, pages 199-244, National Bureau of Economic Research, Inc.
    4. Lahura, Erick & Vega, Marco, 2013. "Regímenes cambiarios y desempeño macroeconómico: Una evaluación de la literatura," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 26, pages 101-119.
    5. Hutchison, Michael M. & Noy, Ilan & Wang, Lidan, 2010. "Fiscal and monetary policies and the cost of sudden stops," Journal of International Money and Finance, Elsevier, vol. 29(6), pages 973-987, October.
    6. Ms. Filiz D Unsal & Mr. F. Gulcin Ozkan, 2014. "On the use of Monetary and Macroprudential Policies for Small Open Economies," IMF Working Papers 2014/112, International Monetary Fund.
    7. Michael Woodford, 2008. "How Important Is Money in the Conduct of Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1561-1598, December.
    8. Fornaro, Luca, 2015. "Financial crises and exchange rate policy," Journal of International Economics, Elsevier, vol. 95(2), pages 202-215.
    9. Louphou COULIBALY, 2018. "Monetary Policy in Sudden Stop-Prone Economies," Cahiers de recherche 06-2018, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    10. Paul Levine, 2012. "Monetary policy in an uncertain world: probability models and the design of robust monetary rules," Indian Growth and Development Review, Emerald Group Publishing, vol. 5(1), pages 70-88, April.
    11. Özge Akinci, 2021. "Financial Frictions and Macro‐Economic Fluctuations in Emerging Economies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(6), pages 1267-1312, September.
    12. Selim Elekdag & Mr. Harun Alp, 2012. "Shock Therapy! What Role for Thai Monetary Policy?," IMF Working Papers 2012/269, International Monetary Fund.
    13. Vasco J. Gabriel & Paul Levine & Joseph Pearlman & Bo Yang, 2010. "An Estimated DSGE Model of the Indian Economy," NIPE Working Papers 29/2010, NIPE - Universidade do Minho.
    14. Ge, Xinyu & Li, Xiao-Lin & Zheng, Ling, 2020. "The transmission of financial shocks in an estimated DSGE model with housing and banking," Economic Modelling, Elsevier, vol. 89(C), pages 215-231.
    15. Vasco Curdia, 2008. "Optimal Monetary Policy under Sudden Stops," 2008 Meeting Papers 474, Society for Economic Dynamics.
    16. Tsangarides, Charalambos G., 2012. "Crisis and recovery: Role of the exchange rate regime in emerging market economies," Journal of Macroeconomics, Elsevier, vol. 34(2), pages 470-488.
    17. Gulcin Ozkan & Filiz Unsal, "undated". "External finance, sudden stops and financial crisis: what is different this time?," Discussion Papers 09/22, Department of Economics, University of York.
    18. Selim Elekdag & Mr. Harun Alp & Mr. Subir Lall, 2012. "Did Korean Monetary Policy Help Soften the Impact of the Global Financial Crisis of 2008-2009?," IMF Working Papers 2012/005, International Monetary Fund.
    19. Mara Pirovano, 2013. "Household and firm leverage, capital flows and monetary policy in a small open economy," Working Paper Research 246, National Bank of Belgium.
    20. Selim Elekdag & Mr. Harun Alp & Mr. Subir Lall, 2012. "An Assessment of Malaysian Monetary Policy During the Global Financial Crisis of 2008-09," IMF Working Papers 2012/035, International Monetary Fund.

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    More about this item

    Keywords

    sudden stops; monetary policy; emerging markets; financial crises;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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