Different Strokes? Common and Uncommon Responses to Financial Crises

IMF Working Papers, January 1, 2001

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Much of the debate about the management of financial crises has focused on structural and psychological issues regarding the conditions that are supposed to be necessary to restore investor confidence.
The paramount requirement in the short term is for countries in crisis to adopt correct macroeconomic policies.
An analysis of conventional macroeconomic models reveals that countries can afford to run expansionary policies to restore internal balance only if they can afford to ignore the requirements for external balance.
This arithmetic does not depend on whether macroeconomic policies were inappropriate before the crisis hit.

Conventional macroeconomic models show a tradeoff: expansionary policies that restore internal balance may conflict with requirements for external balance.
The feasibility of expansionary policies during crises is conditional on the ability to disregard external balance constraints.
Structural and psychological factors (investor confidence conditions) are prominent in debate but are secondary in the short-term priority of correct macroeconomic policy.

Short-term crisis management should prioritize correct macroeconomic policies aimed at restoring internal balance.
Policymakers must assess whether external balance constraints can be safely ignored before pursuing expansionary policies.
Consideration of structural reforms and measures to restore investor confidence remains important but should not displace immediate macroeconomic stabilization needs.

Different Strokes? Common and Uncommon Responses to Financial Crises - WP/01/12
- Different Strokes? Common and Uncommon Responses to Financial Crises - WP/01/12 (Markdown version)
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