External Finance, Sudden Stops, and Financial Crisis: What is Different This Time?

July 1, 2010

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper develops a two-country DSGE model to investigate the transmission of a global financial crisis to a small open economy. We find that economies hit by a sudden stop arising from financial distress in the global economy are likely to face a more prolonged crisis than sudden stop episodes of domestic origin. Moreover, in contrast to the existing literature, our results suggest that the greater a country's trade integration with the rest of the world, the greater the response of its macroeconomic aggregates to a sudden stop of capital flows.

Subject: Consumption, Currencies, Financial crises, Labor, Money, National accounts, Return on investment, Self-employment

Keywords: capital demand, capital goods, Consumption, Currencies, domestic economy, DSGE model, economy variable, Emerging Markets, equilibrium mark-up, Financial Crises, financial crisis, Global, net export, nominal price, optimal contract, price adjustment cost, price level, production firm, Return on investment, risk premium, Self-employment, Sudden Stops, WP

Pages:
34
Volume:
2010
DOI:
https://doi.org/10.5089/9781455201419.001
Issue:
158
Series:
Working Paper No. 2010/158
Stock No:
WPIEA2010158
ISBN:
9781455201419
ISSN:
1018-5941

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