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Financial Crises

Financial Crises. East Asia 1997, Russia 1998, Brazil ?. Background to 1997 East Asian crisis. Fundamentalist view Contagion view Three factors : Macro policy in OECD Domestic mismanagement Investor panic. Exchange Rates. Goldstein 1998. Stock Markets. Goldstein 1998.

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Financial Crises

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  1. Financial Crises East Asia 1997, Russia 1998, Brazil ?

  2. Background to 1997 East Asian crisis • Fundamentalist view • Contagion view Three factors: • Macro policy in OECD • Domestic mismanagement • Investor panic

  3. Exchange Rates Goldstein 1998

  4. Stock Markets Goldstein 1998

  5. IMF Growth Forecasts for 1998 Goldstein 1998

  6. External Causes • Credit boom in the 1990s • Low interest rates in the U.S. and Japan • Expansion of portfolio funds • $420 billion net flows to Asian emerging markets • Deteriorating current account • Overvalued real exchange rates • Slowing exports and increasing competition

  7. External Sector Goldstein 1998

  8. Financial Market Vulnerabilities Capital inflows concentrated: • Real estate (30-40% of bank lending) • Equities • Borrowing in foreign currencies w/ short maturities Why?

  9. Financial Market Supervision • Weak banking sectors—high ratios of nonperforming loans • Lack of transparency, sound accounting procedures • Inadequate loan-loss reserves • Corrupt lending • Banks as quasi-fiscal agents

  10. Precipitating event • Thailand—CB reserves depleted, rolling over government debt • S. Korea—rolling over foreign-currency denominated bank liabilities • Indonesia—corporations attempt to hedge their currency positions

  11. Contagion • Trade linkages? • Hard to explain contagion from small countries to large ones • Competitive devaluation? • Same objection • Goldstein’s “wake-up call” hypothesis • Do capital markets sleep? • Rational buffalo

  12. Russia 1998 • Fixed exchange rate, overvalued in real terms • Incentive to run a fiscal deficit • Election of 1996 • Collapse of tax revenues • Nominal debt • High interest rates • Central Banking dilemmas • Bail-out of 1998

  13. Why not Brazil in 2002? • Public debt to GDP: 60% • Of which, linked to the dollar: 40% • Spread over U.S. treasuries: 18% • Devaluation: >40% in 2002 • $30 billion IMF program in August • Luiz Inacio Lula da Silva (Lula) elected in October

  14. First Steps • Reaffirm primary surplus goal of 3.75% of GDP, an IMF condition • Propose legislation to strengthen Central Bank’s independence • Conservative appointments • Postponing populist agenda

  15. Discussion Do IMF rescue packages help countries that face financial crises?

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