The Effects of Monetary and Fiscal Policies on the Output Costs of Sudden Stops

Abstract

There has been controversy about the appropriate responses of monetary and fiscal policies to sudden stops of capital inflows. There have been concerns that expansionary policies could undermine confidence leading to currency depreciation and a worsening of the crisis. Previous literature has generally found favorable effects from fiscal expansion and mixed results for monetary policy. We revisit this issue using more recent data and alternative measures of monetary policy. We find considerable support for the view that expansionary monetary policy reduces output costs of sudden stops and no significant evidence that the costs are increased. We find that fiscal expansion by countries with low levels of debt is expansionary, but that these effects can become negative at high levels of debt.