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For nearly a quarter of a century, the US has persistently run significant current account deficits that transformed it from the world’s largest net creditor to its largest debtor. The stochastic optimal control/dynamic programming approach provides a framework to derive the optimal debt ratio, based upon both objective variables and preferences. The following set of questions are answered: What is a sustainable ratio of external debt/GDP? What are the consequences of an “excessive” debt? By how much does the dollar need to decline in order to achieve a sustainable current account position for the US and rest of world? The deviation of the actual debt ratio from the derived optimum increases the vulnerability of the economy to external shocks.

The Argentine crisis has been variously blamed on fiscal imbalances, real overvaluation, and self-fulfilling investor pessimism triggering a capital flow reversal. This chapter provides a full assessment of the role of these and other ingredients in the collapse. It shows that in the final years of its Convertibility program, Argentina was not hit harder than other emerging markets in Latin America by global terms-of-trade shocks and financial disturbances. Hence the crisis reflects primarily the high vulnerability to disturbances built into Argentina’s policy framework. These fragilities reinforced each other in such a way that taken jointly they led to a much larger vulnerability to adverse external shocks than in any other country in the region.

the chapter discusses the adequate monetary policy response to management of external shocks that deteriorate the balance of payments and contracts aggregate demand. To this end the author develops an IS-LM-BP type of model adapted to the financial conditions of Peru, where the banking system operates in both domestic and foreign currency.

This chapter discusses the rationale for multilateral lending. It describes three types of multilateral lending including countercyclical provision of liquidity to meet temporary current account imbalances, lending to countries facing capital account crises in order to bail out private creditors, and development finance. It explains that the rationale for countercyclical lending has become stronger in light of the increased instability of the international economic environment, the procyclical behavior of international financial markets and greater vulnerability of developing countries to external shocks.

This chapter focuses on the response of the various econometric models to a number of alternatively specified external shocks. Altogether, 11 model groups supplied simulation results for the model comparisons. These groups represent a cross section of the currently active model operators and forecasters. They run from the now traditional Keynesian to the monetarist and the rational expectations approaches. The participating model groups and the special characteristics of their models are listed in the chapter. Early in the meetings of the model comparison seminar, the philosophy of model comparisons was a topic of some extensive discussion. The approach was to compare alternative “disturbed” model solutions to a base solution. Each model operator was instructed to prepare a so-called “tracking solution” that would approximately reproduce history over the period 1975 to 1984.

The Hong Kong dollar was fixed against the pound sterling until June 1972. Since 1983, it has been fixed against the US dollar. The linked exchange rate connects Hong Kong with the international economy, and provides an anchor which maintains the community's faith in the currency and people's confidence in the government's management of monetary policy. However, the linked exchange rate also narrows the policy options available to the authorities to withstand external shocks. The opening of China, the Asian financial crisis and the global financial tsunami placed conflicting requirements on the direction of price adjustments. The public and quasi-public sector have not adjusted well in response to these events, and the property wealth has become more unevenly distributed. The domestic economy and its numerous sectors therefore have to possess a higher degree of flexibility and agility in an attempt to accommodate and absorb the external impacts.

This chapter examines the main differences between the development of Malaysia and that of other small resource-abundant countries that did not achieve competitive industrialisation. It discusses the high growth of Malaysian investment, public sector contribution to total investment, Malaysia’s open trade regime, industrial policy that fostered competitive industrialisation, and the accumulation of human capital. It reviews Malaysia’s capacity to manage external and internal shocks without experiencing a growth collapse.

Chapter 1 summarizes the main theses of the book and provides an overview of the contents of each of its chapters. It argues that the episodes of rapid economic growth (during the Porfiriato and postwar industrialization), in addition to political stability and a favorable international economic environment, have in common the establishment of a consensus on economic policy matters, the presence of correct perceptions by the political and economic elites on the true constraints on economic development, and a very unequal distribution of the benefits of economic growth, which in turn led to the loss of consensus in the subsequent periods of stagnation. By contrast, the periods of economic stagnation tend to feature political instability and external economic shocks, together with misperceptions among the country's elites and/or the absence of consensus.

This chapter discusses the pre-1989 Cuban economic structure and examines how the post-1989 external shocks filtered through the Cuban economy. It discusses how the reform process in Cuba shifted in 1993–4 to a more dramatic approach to reforming the economy, including the depenalization of dollar use, legalization of self-employment, and the emergence of free markets in agricultural products. It also discusses various political blockages to economic reform. It concludes by analysing the factors that could ease a transition to some form of market economy in Cuba and sketches some likely scenarios for the future.

Emerging economies have been subject to abrupt reversals in capital flows, which have adverse consequences for economic activity and financial stability. An important question for policymakers is how to respond to a sudden loss of external financing and its negative effects on the domestic economy. The experience of emerging economies throughout the recent financial crisis shows that those economies with relatively better economic fundamentals were able to implement countercyclical policies. This chapter provides a simple analytical framework to rationalize this evidence. In particular, it addresses this issue by developing a small-scale macroeconomic model of the New-Keynesian type. Numerical exercises illustrate how both credible monetary and fiscal policies increase policymakers’ degrees of freedom to respond to adverse external shocks.

This chapter presents a framework of transitions to democracy that includes international variables (external shocks, direct active policies of international actors, and larger trends in the international system) using theoretical assumptions drawn from international relations theories. One of the major problems in the literature on democratisation and its use of international relations theory is its over-reliance on structural economics, particularly when it comes to the Arab world. What should be analysed instead are the international economic and the geostrategic dimensions together. Thus, this chapter focuses on the interaction between structural factors and path-dependent decision-making, which means taking tools of analysis from different theories of international relations and relating them to processes of regime change. Determining where the country is inserted in the international system is vital to understanding how domestic actors and institutions are conditioned in their strategies and their decision-making abilities. For the analysis of Algeria, it is useful to look at rentierism and the geopolitics of the Mediterranean to further specify how the two dimensions work.

The first element that needs to be analysed is the role played by the economic crisis of 1985–1986 in ‘forcing’ the ruling elites in Algeria to open up the system. Government revenues fell due to the oil counter-shock, resulting in widespread impoverishment among the general population, which in turn led to the October 1988 riots. The question that should be asked is whether the externally driven downturn in the economy had a causal link to the decision to liberalise. The FIS contends that it was the lack of political legitimacy rather than the economic crisis that led the ruling elites to try a new strategy of re-legitimisation. This chapter discusses external shocks and direct active policies and their impact on Algeria's transition to democracy, focusing on the war in Afghanistan and its consequences and repercussions on Islamism in the country, the 1990–1991 Gulf War, the end of the Cold War, the West's promotion of democracy, promotion of political Islam, and the role of financial institutions and multinationals.

This chapter examines the welfare implications of changing wage and employment situations in the informal sector by constructing a comprehensive model. The structure involves an agricultural sector and incorporates several allied issues central to the considerably neglected analytical relationship between agriculture and informal activities. It is well known that better prospects for agricultural exports and productivity should increase agricultural wages. However, such an outcome depends on capital movement between the formal and informal manufacturing sectors. The inter-relationship sought between the agricultural and manufacturing sectors offers added value to a general set of results that focus on effects of external shocks to movements in informal wages and employment.

This chapter examines the state of monetary and exchange rate policies in China. China’s increasing openness to trade and financial flows and the economy’s gradual transition to a market-oriented policy has increased the importance of developing an effective monetary policy framework. Monetary policy plays a crucial role in macro-economic and financial stability, helps to promote the efficient allocation of resources, and serves as a buffer against internal and external shocks. Despite the evolution of China’s monetary policy framework over time, it remains constrained by a managed exchange rate regime, institutional weaknesses, and an underdeveloped financial system that reduces the potency of the monetary transmission mechanism.