Monetary policy fails to offset external credit squeeze during severe crises.
Firms in emerging markets face financial challenges worsened by sudden capital flow stops. Monetary policy can help during moderate contractions but not severe crises. When crises hit, expanding monetary policy doesn't boost economic activity much. Trying to defend the exchange rate can make sudden stops worse by discouraging private sector precautions. Dollarizing liabilities doesn't help much during sudden stops and can lead to underinsurance.