subperiod. There is no evidence that the breakdown of those prior inflows into portfolio and other (bank-related) flows makes a difference for the magnitude of the output drop.

# **4. The Policy Response**

We next consider how countries adjust policy in response to sudden stops. If there is a conventional wisdom, it is that they tighten monetary and fiscal policies to counter the drop in the exchange rate and in an effort to restore confidence. In extreme cases, they tighten controls on capital outflows and appeal to the International Monetary Fund for emergency assistance.

In fact, this conventional response is evident in only a minority of cases. In only 8 of the 43 cases considered here did countries in fact tighten both monetary and fiscal policies in response to sudden stops. Over the entire period, monetary policy was eased in response to sudden stops more often than it was tightened. Instead (or in addition), governments respond to sudden stops with a variety of other measures targeted at buttressing the stability of their domestic financial system and signaling to investors their commitment to sound and stable policies.

Moreover, there are differences in the nature of the typical response between the first and second subperiods. There was less of a tendency to tighten both monetary and fiscal policies in the second subperiod. In both subperiods countries experiencing sudden stops moved in the direction of a more flexible exchange rate, but that tendency was more pronounced in the first subperiod than the second. And, there is more recourse to the IMF and program finance in the first subperiod.

As measures of the stance of monetary and fiscal policies, we consider changes in policy interest rates and announcements of tax increases and expenditure changes. Information on IMF programs, fiscal and monetary policies, and structural reforms is gathered from IMF Article IV reports, program and other documents, and Haver Research and other market-oriented websites. We rely on IMF’s AREAER to code changes in exchange rate arrangements, changes in capitalaccount liberalization and restriction measures, and macroprudential policy measures.<sup>20</sup> A first pattern in Table 9 is that a majority of countries experiencing sudden stops between 1991 and 2014 in fact eased monetary policy in response, whereas a majority tightened fiscal policy. Countries experiencing sudden stops need to simultaneously do something to reduce the level of spending relative to income when foreign finance becomes more difficult to tap, while at the same time taking other steps to support economic activity and aid the financial system.<sup>21</sup> Fiscal tightening evidently is the preferred policy to pursuing the former, while monetary easing the preferred instrument for achieving the latter. Governments could conceivably adopt the opposite policy mix, but in only 1 of 44 episodes do we observe this response. Budget deficits become more difficult to finance in the wake of sudden stops, especially if monetary policy is tightened, making some degree of fiscal consolidation inevitable for countries with preexisting fiscal deficits. Monetary tightening could reinforce the

> 20 For macroprudential policy initiatives, we utilized AREAER information under heading XII: Provisions specific to the financial sector, supplemented with information from IMF Article IV reports.

> 21 One is reminded, for example of Brazil’s response to its sudden stop in 2015, which entailed fiscal consolidation and a reluctance to tighten monetary policy (keeping central bank interest rates on hold in a period when inflation was rising).

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