International Financial Crises

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International Financial Crises

• What happened in Asia?
• Globalization, 17.195
• R. Bonoan J. Shapiro
• November 21, 1999

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• Government policies toward the financial system
• Bank-centered financial system
• Weak bank supervision
• Moral hazard (Banks used as instrument of public
  policy and too big to fail)

• Government macroeconomic policy
• Fixed exchange rate
• Loose fiscal policy (persistent budget deficits)

• Macroeconomic vulnerability
• High relative inflation caused by expansion of
  money supply
• Real exchange-rate appreciation
• Widening of current account deficit

Inflow of foreign capital

• Misallocation of capital
• Overinvestment
• Asset price bubble
• Corruption

• Government policies toward foreign capital
• Capital account liberalization biased toward
  short-term capital
• Foreign capital used to finance public debt

• Debt Maturity Structure
• Accumulation of short-term debt denominated in
  foreign currency

• Triggers
• Depletion of foreign exchange reserves
• Economic vulnerabilities revealed
• Credibility of fixed exchange rate undermined

• Financial vulnerability
• To banking crisis
• To public debt crisis

International Financial Crises 1.
Vulnerabilities Triggers

• Crisis
• Speculative attack on currency
• Capital outflow
• Spectre of public debt default

• Triggers
• Economic vulnerabilities revealed
• Credibility of fixed exchange rate undermined

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2. International Financial Crises Government
Response and Feedback Mechanisms

• Depletion of foreign exchange reserves
• Credibility of fixed exchange rate further
  undermined

• Crisis
• Speculative attack on currency
• Capital outflow
• Spectre of public debt default

• Exchange rate pegunder pressure
• Macroeconomic imbalances
• Competitive devaluation

• Financial system further weakened
• High interest rates force borrowers into default
• Specter of bank bailout
• Credibility of fixed exchange rate further
  undermined

• Incentives to devalue increase
• Credibility of fixed exchange rate further
  undermined

• Domestic economy weakens
• Bankruptcies/bank collapses
• Increasing unemployment
• Rising political unrest

Government raises domestic interest rates
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• Government policies toward financial system
• Bank-centered financial system
• Weak bank supervision
• Moral hazard (Banks used as instrument of public
  policy and too big to fail)

Inflow of foreign capital

• Misallocation of capital
• Overinvestment
• Asset price bubble (real estate)
• Corruption

• Financial vulnerability
• To banking crisis
• Public debt crisis

• Triggers
• Economic vulnerabilities revealed (bank
  collapses corruption exposed)
• Credibility of fixed exchange rate undermined

• Crisis
• Speculative attack on currency
• Capital outflow

The Asian Financial Crisis 3. Crony Capitalism
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Crony Capitalism
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• Government policies toward foreign capital
• Capital account liberalization biased toward
  short-term capital

• Debt Maturity Structure
• Accumulation of short-term debt denominated in
  foreign currency

• Financial vulnerability
• To banking crisis

• Triggers
• Economic vulnerabilities revealed (collapse of
  chaebol revelation of true short-term debt
  burden)
• Credibility of fixed exchange rate undermined

The Asian Financial Crisis 4. Short-term Capital
Flows (South Korea)

• Crisis
• Speculative attack on currency
• Capital outflow

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Short-term Capital Flows
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• Causes of foreign capital inflow
• Expansionary monetary policy in money centers
  (US, Europe, and Japan)
• Excess world liquidity (yen bubble)
• Financial deregulation in Europe
• Higher interest rates in Asian countries
  relative to money centers
• Asian countries liberalize capital accounts

• Government macroeconomic policy
• Fixed exchange rate (dollar peg)

• Macroeconomic vulnerability
• High relative inflation caused by expansion of
  domestic money supply
• Real exchange-rate appreciation (also because
  dollar strengthening)
• Widening of current account deficit

Inflow of foreign capital

• Triggers
• Depletion of foreign exchange reserves
• Economic vulnerabilities revealed (real estate
  bubble bursts and Bangkok Bank of Commerce
  fails)
• Credibility of fixed exchange rate undermined

The Asian Financial Crisis 5. Macroeconomic
Fundamentals (Thailand)

• Crisis
• Speculative attack on currency
• Capital outflow

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Macroeconomic Fundamentals
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Conclusions

• Multiple variables to consider
• Variance across countries
• Not all factors were present in all countries
• Triggers were important
• Vulnerabilities not sufficient to cause crisis
• Several paths to crisis
• Was the crisis inevitable?
• How much weight should be assigned to each path?