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Policy Rules and Large Crises in Emerging Markets

In response to the COVID-19 pandemic, Latin American countries temporarily suspended rules limiting debt, fiscal and monetary policies. Despite this increase in flexibility, the crisis implied a substantial deterioration of macroeconomic variables (e.g., real GDP declined by 9.5%) and high welfare costs (which we estimate as equivalent to a 13% one-time reduction in non-tradable consumption). This paper studies a sovereign default model with fiscal and monetary policies to assess the policy response and evaluate the gains from flexibility in times of severe distress.

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https://doi.org/10.20955/wp.2022.018