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Working Paper
Managing Capital Flows in the Presence of External Risks
We introduce external risks, in the form of shocks to the level and volatility of world interest rates, into a small open economy model subject to the risk of sudden stops?large recessions together with abrupt reversals in capital inflows| and characterize optimal macroprudential policy in response to these shocks. In the model, collateral constraints create a pecuniary externality that leads to "overborrowing" and sudden stops that arise when the constraints bind. The typical sudden stop generated by the model replicates existing empirical evidence for emerging market economies: Low and ...
Working Paper
Interest Rate Volatility and Sudden Stops : An Empirical Investigation
Using a multi-country regime-switching vector autoregressive (VAR) model we document the existence of two regimes in the volatility of interest rates at which emerging economies borrow from international financial markets, and study the statistical relationship of such regimes with episodes of sudden stops. Periods of high volatility tend to be persistent and are associated with high interest rates, the occurrence of sudden stops in external financing, and large declines in economic activity. Most strikingly, we show that regime switches drive the countercyclicality of interest rates in ...