The effectiveness of fiscal and monetary policy responses to twin crises

Abstract

We study how effective fiscal and monetary policy responses are during a twin crisis. Using the dataset provided by Laeven and Valencia (2008), we identify 57 episodes of twin crises. Following the methods proposed in Baldacci et al. (2009) and Hutchison et al. (2010), we construct the variables measuring the duration and output cost of a twin crisis. We find that fiscal policy does not seem to be associated with the shortening of a twin crisis. Regarding monetary policy, we find that monetary tightening is associated with the lengthening of a twin crisis duration, consistent with the result in Hutchison et al. (2010) dealing with a sudden stop crisis. In addition, our results show that while a mild monetary expansion is effective in reducing a twin crisis duration, over-expansionary monetary policy loses its effectiveness.