The Credit Crunch and its Macroeconomic Impacts in Small-Open Developing Economies: A Dynamic Stochastic General Equilibrium Analysis

This study, investigates the macroeconomic impacts of the credit crunch on small-open developing economies. A Dynamic Stochastic General Equilibrium (DSGE) model is developed as the theoretical framework, while the methodology is based on simulation and calibration using Markov Chain Monte Carlo (MCMC) techniques. The study establishes that the current credit crunch of 2007-2009 could generate devastating effects in developing economies just as in industrialized economies. The credit crunch could affect developing economies through three main channels the resource-flows channel, global prices channel and macroeconomic shocks channel. Overall, in a typical developing economy, the credit crunch could generate inflationary spiral, exchange rate appreciations, widening current account and budget deficits with increasing domestic borrowings and macroeconomic stagnation as reflected in declines in output, net exports, tax revenue and public investment. The study recommends that developing countries should plan for some kind of stimulus packages to assuage the adverse effects of the crisis on output, inflation, exchange rate and fiscal aggregates. The models developed in this study can be used in analyzing the effects of future external shocks on developing economies, which is a very important study in the field of economics.