Domestic Antidotes to Sudden Stops

Sudden Stops in net capital flows can be prevented when theactions of domestic investors offset a reduction in foreign lending. We presentevidence that while sudden stops in gross inflows – i.e., a tightening of theexternal... [ view full abstract ]

Sudden Stops in net capital flows can be prevented when theactions of domestic investors offset a reduction in foreign lending. We presentevidence that while sudden stops in gross inflows – i.e., a tightening of theexternal borrowing constraint– are associated with global conditions andtherefore, are largely outside of the control of local policymakers, domesticfactors such as low levels of domestic liability dollarization, exchange rateflexibility, inflation targeting regimes, and a solid institutional backgroundare important to prevent these episodes from becoming sudden stops in net capital flows. Under these favorable local conditions, domestic investors mayperceive reduced risk in bringing in resources at the time of an externalshock, thus insulating the country from the original shock.