Recent Currency Crises in East Asia

February, 2002

Economic Policy, 2001

for dicussions and comments on earlier drafts. We also wish to thank several colleagues at the IMF for data and information on IMF financial operations, including

1999

This paper provides an asymmetric information analysis of the recent East Asian crisis. It then outlines several lessons from this crisis. First, there is a strong rationale for an international lender of last resort. Second, without appropriate conditionality for this lending, the moral hazard created by operation of an international lender of last resort can promote financial instability. Third, although capital flows did contribute to the crisis, they are a symptom rather than an underlying cause of the crisis, suggesting exchange controls are unlikely to be a useful strategy to avoid future crises. Fourth, pegged exchange-rate regimes are a dangerous strategy for emerging market countries and make financial crises more likely.

2004

It is often argued that the provision of liquidity by the international institutions such as the IMF to countries experiencing balance of payment problems can have catalytic effects on the behavior of international financial markets, i.e., it can reduce the scale of liquidity runs by inducing investors to roll over their financial claims to the country. Critics point out that official lending also causes moral hazard distortions: expecting to be bailed out by the IMF, debtor countries have weak incentives to implement good but costly policies, thus raising the probability of a crisis. This paper presents an analytical framework to study the trade-off between official liquidity provision and debtor moral hazard. In our model international financial crises are caused by the interaction of bad fundamentals, self-fulfilling runs and policies by three classes of optimizing agents: international investors, the local government and the IMF. We show how an international financial institution helps prevent liquidity runs via coordination of agents' expectations, by raising the number of investors willing to lend to the country for any given level of the fundamental. We show that the influence of such an institution is increasing in the size of its interventions and the precision of its information: more liquidity support and better information make agents more willing to roll over their debt and reduces the probability of a crisis. Different from the conventional view stressing debtor moral hazard, we show that official lending may actually strengthen a government incentive to implement desirable but costly policies. By worsening the expected return on these policies, destructive liquidity runs may well discourage governments from undertaking them, unless they can count on contingent liquidity assistance.

Journal of Monetary Economics, 2006

It is often argued that the provision of liquidity by the international institutions such as the IMF to countries experiencing balance of payment problems can have catalytic effects on the behavior of international financial markets, i.e., it can reduce the scale of liquidity runs by inducing investors to roll over their financial claims to the country. Critics point out that official lending also causes moral hazard distortions: expecting to be bailed out by the IMF, debtor countries have weak incentives to implement good but costly policies, thus raising the probability of a crisis. This paper presents an analytical framework to study the trade-off between official liquidity provision and debtor moral hazard. In our model international financial crises are caused by the interaction of bad fundamentals, self-fulfilling runs and policies by three classes of optimizing agents: international investors, the local government and the IMF. We show how an international financial institution helps prevent liquidity runs via coordination of agents' expectations, by raising the number of investors willing to lend to the country for any given level of the fundamental. We show that the influence of such an institution is increasing in the size of its interventions and the precision of its information: more liquidity support and better information make agents more willing to roll over their debt and reduces the probability of a crisis. Different from the conventional view stressing debtor moral hazard, we show that official lending may actually strengthen a government incentive to implement desirable but costly policies. By worsening the expected return on these policies, destructive liquidity runs may well discourage governments from undertaking them, unless they can count on contingent liquidity assistance.

2016

A consensus has not been reached in the ongoing debate on the effects of lender of last resort functions by the IMF, given the contradictory results from macroeconomic analyses that depend upon samples and periods. This paper sheds new light on the relationship between international banks and their home governments, the IMF and international regulators during the years that preceded the debt crisis of 1982. Based on new archival evidence, we find that commercial banks’ decisions to lend were largely based on home governments’ preferences, competition, and the assumption that home governments and international organizations would provide lending of last resort functions to support borrowing governments. These factors also influenced loan pricing. While previous works suggest that the 1982 debt crisis was unexpected, we show that banks reacted to the deteriorating macroeconomic situation in many emerging economies once the role of international organizations as lenders of last resort ...

International Finance, 1998

The dramatic nature of the exchange rate collapses in Asia has greatly stimulated efforts to understand and control the forces that cause such crises. While currency crises are not new, those in Asia stand out both because of the severity of the economic dislocations and because they do not seem to fit the standard explanations. The Asian crises lack the clear evidence of distorted domestic macroeconomic conditions that were believed to be key to most past currency crises, yet they are among the most extreme in terms of the magnitude of exchange rate depreciation and output loss. Instead, the Asian vulnerability derived from microeconomic weaknesses in their domestic banking systems and extreme levels of exposure to exchange rate risk by those who borrowed in foreign markets. In this regard, the experience reinforces prior warnings of the dangers of removing controls on international capital flows in the presence of weak, or repressed, financial systems. Second, the Asian crises have promoted an intensified discussion of the appropriate policy response to a crisis, both by the countries involved and by the International Monetary Fund. With capital account convertibility, the potential magnitude of sudden claims on a country's foreign exchange reserves far exceeds the levels observed in earlier currency crises. Under such circumstances, how can countries effectively respond to a run on their currencies, and should the International Monetary Fund step in as a lender-of-last-resort? Can a lender-oflast-resort function be sustained at the international level in the absence of strong prudential supervision of financial institutions and markets without raising intolerable problems of moral hazard?

Handbook of International Economics, 2014

The paper surveys recent research on international financial crises. A financial crisis is characterized by a sudden, dramatic outflow of financial resources from an economy with an open capital account. This outflow may be primarily driven by the expectation of a large nominal devaluation, in a situation in which the domestic monetary-fiscal regime appears inconsistent with a fixed exchange rate. Or the outflow may be driven by a reallocation of funds by foreign and domestic investors, due to a changed perception in the country's growth prospects, to an increase in the risk of domestic default, or to a shift in investors' attitudes towards risk. Often times, monetary and financial elements are combined. A drop in domestic asset prices and in the real exchange rate can act as powerful amplifiers of the real effects of the crisis, through adverse balance-sheet adjustments. The paper surveys research that looks both at the monetary and at the financial side of crises, also discussing work that investigates the accumulation of imbalances preceding the crisis and the scope for preventive policies.