Edmund Phelps and Gylfi Zoega
Julián Messina, Claudio Michelacci, Jarkko Turunen and Gylfi Zoega
Alison L. Booth, Marco Francesconi and Gylfi Zoega
Edited by Julián Messina, Claudio Michelacci, Jarkko Turunen and Gylfi Zoega
Hamid Raza, Bjorn Runar Gudmundsson, Gylfi Zoega and Mikael Randrup Byrialsen
This paper attempts to explain the role of capital inflows in creating economic booms and busts in a small open economy with sovereign currency. We develop a stock–flow consistent (SFC) model for a small open economy while relying on the experience of the Icelandic crisis. We demonstrate the destabilising effects of capital inflows on the economy by allowing for a sudden stop, and also discuss the role of capital controls as a policy response in the event of a crisis due to sudden stops. Finally, we discuss the policy implications of our results in order to tackle the destabilising effects associated with financial flows in a small economy.
Hamid Raza, Mikael Randrup Byrialsen, Bjorn Runar Gudmundsson and Gylfi Zoega
The aim of this chapter is to understand the international dimension of the crisis in small open economies, which experienced persistent current account deficits before the global financial crisis. We develop a theoretical framework to explain the role of capital inflows in creating economic booms in a small open economy with sovereign currency. We demonstrate the destabilizing effects of capital inflows on the economy. We conclude that large speculative inflows generate debt-led booms, which are not sustainable in the long run. The episode of boom is followed by a bust, which is usually stronger in magnitude than the preceding boom. In particular, sovereign regimes are easily destabilized due to currency risk premiums and large trade balance effects. However, they also have the potential to adjust more rapidly owing to exchange rate flexibility, capital control and autonomous restructuring of the financial sector