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Fear of Sudden Stops: Lessons from Australia and Chile

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Author Info
Ricardo J. Caballero
Kevin Cowan
Jonathan Kearns

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Abstract

Latin American economies are exposed to substantial external vulnerability. Domestic imbalances and terms of trade shocks are often exacerbated by sudden financial distress. This paper explores ways of overcoming external vulnerability, drawing lessons from a detailed comparison of the response of Chile and Australia to recent external shocks and from Australia`s historical experience. It is argued that, in order to understand sudden stops and the mechanisms to smooth them, it is useful to highlight and then draw a distinction between two dimensions of investor confidence: country-trust and currency-trust. While these two dimensions are interrelated, there are important distinctions. Lack of country-trust is a more fundamental and serious problem behind sudden stops. But lack of currency-trust may be a source of country-trust problems as well as weaken a country`s ability to deal with sudden stops. The paper further discusses steps to improve investor confidence in the medium run along these two dimensions, as well as policies to reduce the impact of country-trust and currency-trust weaknesses in the short run.

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Paper provided by Inter-American Development Bank, Research Department in its series RES Working Papers with number 4363.

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Date of creation: Jul 2005
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Handle: RePEc:idb:wpaper:4363

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  2. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December. [Downloadable!] (restricted)
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  3. Barry Eichengreen & Ricardo Hausmann & Ugo Panizza, 2003. "Currency Mismatches, Debt Intolerance and Original Sin: Why They Are Not the Same and Why it Matters," NBER Working Papers 10036, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2001. "Currency crises and monetary policy in an economy with credit constraints," European Economic Review, Elsevier, vol. 45(7), pages 1121-1150. [Downloadable!] (restricted)
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  6. Stephen Grenville, 1997. "The Evolution of Monetary Policy: From Money Targets to Inflation Targets," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia. [Downloadable!]
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  9. Ricardo J. Caballero, 2002. "Coping with Chile’s External Vulnerability: A Financial Problem," Working Papers Central Bank of Chile 154, Central Bank of Chile. [Downloadable!]
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