Policy Rules and Large Crises in Emerging Markets

RePEc Short ID: pko790
ORCID iD: 0000-0001-8464-2470

Espino, Emilio; Kozlowski, Julian; Martin, Fernando M.; Sanchez, Juan M.

doi:10.20955/wp.2022.018

Working Paper Revision

Policy Rules and Large Crises in Emerging Markets

Abstract: Emerging economies have adopted fiscal and monetary rules to discipline government policy. We study the value and macroeconomic implications of rules and flexibility within a sovereign-default model that incorporates domestic fiscal and monetary policies and long-term external debt. Adopting monetary targets and debt limits during normal times yields welfare gains. Suspending rules can significantly influence policy, macroeconomic outcomes, and welfare during large, unforeseen crises. The gains from flexibility depend on how quickly policymakers are able to reimpose rules after the crisis.

Keywords: crises; default; sovereign debt; emerging markets; exchange rate; inflation; fiscal policy; monetary policy; rules; discretion; Markov-perfect equilibrium; COVID-19;