Discussion Papers in Economics

This paper develops a two-country dynamic, stochastic general equilibrium (DSGE) model to investigate the transmission of a global (cid:133)nancial crisis to a small open economy. Central to our framework are (cid:133)nancial frictions that play a major role in the macroeconomic adjustment to global credit tightening. Our two-country set-up with explicit consideration of both (cid:133)nancial and trade channels between the countries enables us to account for some important aspects of the current global (cid:133)nancial crisis experience. We (cid:133)nd that small open economies hit by a sudden stop arising from (cid:133)nancial distress in the global economy are likely to face a more prolonged crisis than when they experience a (cid:133)nancial shock of domestic origin. This is because an important source of di¢ culty in responding to a global (cid:133)nancial 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 (cid:133)nancial distress -as is painfully experienced by many countries in contemporary times. Moreover, in contrast to the existing literature, our results suggest that the greater a country(cid:146)s trade integration with the rest of the world, the greater the response of its macroeconomic aggregates to a sudden stop of capital (cid:135)ows.

[1]  R. Michie.  This time is different: eight centuries of financial folly , 2010 .

[2]  Vasco Cúrdia.  Optimal Monetary Policy Under Sudden Stops , 2009 .

[3]  Vasco Cúrdia.  Monetary Policy under Sudden Stops , 2007 .

[4]  G. Calvo,et al.  Relative Price Volatility Under Sudden Stops: The Relevance of Balance Sheet Effects , 2005 .

[5]  M. Bleaney.  The Aftermath of a Currency Collapse: How Different are Emerging Markets? , 2005 .

[6]  G. Calvo,et al.  On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects , 2004 .

[7]  Ivan Tchakarov,et al.  Balance Sheets, Exchange Rate Policy, and Welfare , 2004, SSRN Electronic Journal.

[8]  Bryan R. Routledge,et al.  Exotic Preferences for Macroeconomists , 2004, NBER Macroeconomics Annual.

[9]  M. Gertler,et al.  External Constraints on Monetary Policy and the Financial Accelerator , 2003 .

[10]  Christopher A. Sims,et al.  SECOND ORDER ACCURATE SOLUTION OF DISCRETE TIME DYNAMIC EQUILIBRIUM MODELS , 2003 .

[11]  J. Campa,et al.  Exchange Rate Pass-Through into Import Prices: A Macro or Micro Phenomenon? , 2002 .

[12]  P. Lane,et al.  Exchange Rates and Monetary Policy in Emerging Market Economies , 2001 .

[13]  A. Velasco,et al.  Balance Sheets and Exchange Rate Policy , 2000 .

[14]  Carmen M. Reinhart,et al.  On crises, contagion, and confusion , 2000 .

[15]  Frederic S. Mishkin.  The Dangers of Exchange-Rate Pegging in Emerging-Market Countries , 1998 .

[16]  Charles T. Carlstrom,et al.  Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis , 1998 .

[17]  B. Bernanke,et al.  The Financial Accelerator in a Quantitative Business Cycle Framework , 1998 .

[18]  M. Knetter,et al.  Goods Prices and Exchange Rates: What Have We Learned? , 1996 .

[19]  B. Naug,et al.  Pricing to Market in a Small Open Economy , 1996 .

[20]  B. Bernanke,et al.  Agency Costs, Net Worth, and Business Fluctuations , 1988 .

[21]  Julio J. Rotemberg,et al.  Sticky Prices in the United States , 1982, Journal of Political Economy.

[22]  J. Córdoba,et al.  Credit Cycles , 2003 .

[23]  I. Gilboa,et al.  Maxmin Expected Utility with Non-Unique Prior , 1989 .