Transcript Chapter 12 - Pearson Higher Education

Chapter 12
International
Financial
Crises
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
Chapter Objectives
• Explore the ways in which financial crises
develop and spread
• Explain why financial crises may occur in
countries with sound macroeconomic policies
• Identify mechanisms to prevent and remedy
financial crises
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-2
Introduction
• Economic integration has enhanced growth and
development, but also made it easier for crises to
spread across borders
• Contagion effects of crises do not conform to a
single patterns, and are thus difficult to predict
• Financial crises could be prevented through a
reform of the international financial architecture
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-3
Financial Crisis
• Financial Crisis: banking crisis, exchange rate
crisis, or a combination of the two
– Banking crisis: banking system’s becoming unable
to perform its normal lending functions
• Disintermediation: banks becoming unable to serve as
intermediaries between savers and investors
• Exchange rate crisis: sudden and unexpected collapse in
the value of a nation’s currency
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-4
Financial Crisis and Exchange
Rates
• Under a fixed exchange rate system, crisis
entails the loss of international reserves and
devaluation
• Under a flexible exchange rate system, crisis
means an uncontrolled, rapid depreciation of the
currency
• Countries with a pegged exchange rate may be
more vulnerable to a crisis
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-5
Two Causes of Financial Crises
• Crises caused by macroeconomic imbalances,
such as large budget deficits caused by overly
expansionary fiscal policies
– Example: Third World debt crisis of the 1980s
• Crises caused by volatile capital flows
– Example: the East Asian financial crisis of 1997–
1998
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-6
Domestic Issues in Crisis
Avoidance
• Problem in financial sector regulation
– Moral hazard: incentive to act in a manner that creates
personal benefits at the expense of the common good: e.g.,
banks have an incentive to make riskier investments when
they know they will be bailed out
– Moral hazard problems are exacerbated by governments’
providing incentives or threatening banks to make bad loans
for political ends
• In East Asian crisis, such loans gave rise to the term crony capitalism
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-7
Escaping Moral Hazard
• The problem of moral hazard is inescapable if policies
to protect the financial sector exist
• Way to decrease the problem: establish supervision and
regulation standards for internationally active banks
– Basel Capital Accord: formulated in 1989 by bank
regulators from industrialized countries; adopted by more
than 100 countries
– The New Basel Capital Accord of 2001 updated the previous
standards
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-8
New Basel Capital Accord
• Recommends three best practices to reduce the problem
of moral hazard
– Capital requirements: require the owners of banks to invest
a certain percentage of their own capital in the bank
– Supervisory review: oversight mechanism to assist with risk
management and to provide standards for daily business
practices
– Information disclosure: requires banks to disclose
operational information to lenders, investors, depositors
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-9
Avoiding Crisis: Exchange Rate
Policy
• Crawling peg increases vulnerability to financial crises
in two ways
– Requires monetary authorities to exercise discipline in the
issuance of new money; anti-inflationary tendencies are
exacerbated by intentional slow devaluation, and a severe
overvaluation of the real exchange rate may result
– Exiting crawling peg is difficult: government leaving it may
lose the confidence of investors
• Current consensus: hard peg or floating rate
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-10
Capital Controls
• Capital controls may be imposed to prevent capital
movements in the financial account
– Inflow restrictions tend to work better than outflow ones:
reduce the inflow of short-run capital, which would add to the
stock of liquid, possibly volatile capital
– Outflow restrictions may help reduce the impact of a crisis,
when it occurs
• Malaysia weathered the Asian Crisis through outflow restrictions
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-11
Managing Crises: Domestic
Policies
• Crises caused by macroeconomic policies can be
cured by:
– Cutting the deficit
– Raising the interest rates
– Letting the currency float
• However, these are politically difficult
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-12
Managing Crises: Domestic
Policies (cont.)
• Crises caused by sudden capital flight are harder
to cure
– Collapsing currency can be defended through
interest rate hikes, but these may cause bankruptcies
and other problems
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-13
Managing Crises in Sum
• Crisis management is politically difficult:
creates losers in the domestic economy
• Fiscal and monetary policies are limited if the
crisis has an international component
– Defending currency with high interest rates: spreads
the recessionary effects of the crisis
– Defending the economy against recessionary effects:
intensifies the problems of a collapsing currency
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-14
Reform of the International
Financial Architecture
• Reform of the international financial architecture:
new international policies for avoiding and managing
financial crises
• The great variety of reform proposals focus on two
issues
– Role of an international lender of last resort
– Conditionality: the changes in economic policy that
borrowing nations are required to make in order to receive
loans from the lender of last resort
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-15
Lender of Last Resort
• Lender of last resort: a source of loanable funds after
all commercial sources of lending become unavailable
– The central bank in the national economy
– The IMF, with the support of high-income countries, in the
international economy
• A country unable to make a payment on its international loans or
lacking international reserves asks the IMF to intervene
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-16
Lender of Last Resort (cont.)
• Opponents of international lender of last resort cite
moral hazard problems
– Trusting in a bailout, failing firms have an incentive to
gamble on high-stakes, high-risk ventures
• Proponents: moral hazard can be decreased by financial
sector regulations, such as the Basel Capital Accord
– If owners of financial firms risk losses in the event of a
meltdown, they will not engage in excessive risk
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-17
Lender of Last Resort (cont.)
• Debate on the IMF’s role as a lender of last resort and
moral hazard centers on
– Level of IMF interest rates: should the rates be higher?
– Length of the payback period: should the period be shorter?
– Size of loans: countries often exceed the borrowing
limitation of 300% above their quota; should the borrowing
limits be curbed?
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-18
Conditionality
• Conditionality: the changes in economic policy that
borrowing nations are required to make in order to
receive loans from the lender of last resort
– Typically covers monetary and fiscal policies, exchange rate
policies, and structural policies affecting the financial sector,
international trade, and public enterprises
– The IMF makes loans in tranches—installments of the total
loan
• Each tranche hinges on the completion of reform targets
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-19
Conditionality (cont.)
• Critics of conditionality argue
– The need to comply with conditionalities may
intensify the recessionary effects of a crisis
– Conditionality may entail high social costs on the
poorest members of the society
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-20
Conditionality (cont.)
• Proponents argue that crises could be avoided by
a pre-qualification criteria
– To receive assistance, countries must meet
requirements of sound financial sector policies
– However, critics claim that (1) prequalification will
not deter speculative attacks on the country´s
currency and (2) IMF could not ignore crises cases
that failed to prequalify
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-21
Emerging Issues in International
Financial Architecture 1
• Need for greater transparency to make a
country’s financial standing clearer to potential
lenders
– Basel Capital Accord includes issues of transparency
and data reporting
– Data dissemination standards: the IMF´s standards
for data reporting; currently under development
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-22
Emerging Issues in International
Financial Architecture 2
• Need to coordinate private sector involvement: private
sector creditors’ insistence they be paid first make it
more difficult to resolve a crisis
• How to resolve the conflict between lenders?
– Standstills: IMF’s recognition that a crisis country
temporarily stop making repayments on its debt
– Collective action clauses: lenders would have to agree on
collective mediation among themselves and the debtor in the
event of a crisis
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-23
Reform Urgency
• Immediately following the Asian Crisis financial
reform was at the top of everyone’s agenda.
• A decade later, not much reform has occurred
and it is no longer at the top of the agenda.
– Attention has been diverted to other areas:
• Security, terrorism, energy, climate change
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-24
Chapter 12
Chapter Art
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
FIGURE 12.1 Pesos Per Dollar:
December 12, 1994 to March 22, 1995
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-26
TABLE 12.1 Current Account
Balances and Currency Depreciations
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-27
TABLE 12.2 Real GDP Growth
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
12-28