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External finance, sudden stops and financial crisis: what is different this time?

  • Gulcin Ozkan
  • Filiz Unsal

This paper develops a two-country dynamic, stochastic general equilibrium(DSGE) model to investigate the transmission of a global financial crisis to a small open economy. Central to our framework are financial frictions that play a major role in the macroeconomic adjustment to global credit tightening. We find that small open economies hit by a sudden stop arising from financial distress in the global economy are likely to face a more prolonged crisis than when they experience a financial shock of domestic origin. This is because an important source of difficulty in responding to a global financial crisis is the inability of countries to export their way out of crisis due to the slump in world consumer demand initiated by the global financial distress -as is painfully experienced by many countries in contemporary times. Moreover, we show that the greater a country's trade integration with the rest of the world, the greater the fluctuation of its macroeconomic aggregates in response to a global financial crisis.

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 09/22.

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Handle: RePEc:yor:yorken:09/22
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  17. Fabio Braggion & Lawrence J. Christiano & Jorge Roldos, 2007. "Optimal Monetary Policy in a 'Sudden Stop'," NBER Working Papers 13254, National Bureau of Economic Research, Inc.
  18. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. "Goods Prices and Exchange Rates: What Have We Learned?," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September.
  19. Mishkin, Frederic S, 1998. "The Dangers of Exchange-Rate Pegging in Emerging-Market Countries," International Finance, Wiley Blackwell, vol. 1(1), pages 81-101, October.
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