Managing external shocks: what central banks can do
External shocks—ranging from commodity-price spikes, wars, and pandemics to foreign monetary tightening and sudden stops of capital—pose immediate and diverse challenges for central banks. The appropriate response depends on the shock’s nature (demand, supply, financial, or external liquidity), its persistence, and the economy’s structural characteristics. This article outlines practical tools, strategic choices, case evidence, and trade-offs central banks face when shocks originate beyond national borders.Identifying external shocks and their policy repercussionsDemand shocks: Sharp contractions in global demand cut export earnings and weaken domestic production. Policy priorities typically pivot to sustaining economic momentum through rate reductions, ample liquidity, and targeted fiscal…
