Transcript Financial Crises in 1990s

Financial Crises in 1990s
International Political Economy
Prof. Tyson Roberts
Lecture Goals
• Causes and consequences of 1990s financial
crises in Asia and South America
• Similarities and differences to the financial
crises in the 1980s
• Political Trilemma of the World Economy
Almost a Decade of Financial Crises in
Developing World
• 1994-5: Mexico
• 1997-8: Indonesia, Malaysia, South Korea,
Thailand
• 1998: Russia
• 1999: Brazil
• 2001: Turkey, Argentina
Causes
(Oatley)
• Liberalization of financial markets => higher
volumes of capital flows to developing world
in form of “hot money”
• Each country had some form of fixed exchange
rate
• Each country had heavy reliance on shortterm foreign private capital inflows
Differences from previous
international financial crises
(Oatley)
• Little to do with government borrowing;
instead originated in weak domestic banking
sectors that had been liberalized
• Larger scale of capital outflows
• Larger scale of economic contraction (worst
since Great Depression)
Financial liberalization
• Enabled banks to tap low interest loans from
foreign commercial banks and lend to
domestic borrowers
• Borrowed short term loans denominated in
foreign currency and lent long term in
domestic currency
Macroeconomic policy trilemma
“The Unholy Trinity”
Fixed exchange rate
Asian currencies
pegged to dollar
Capital mobility
Floating exchange rate
Monetary autonomy
7
Asia largest recipient of capital inflows pre-1997
Real GDP per capita doubled or tripled
in East & Southeast Asian economies in 16 years
Financial liberalization
• How did financial liberalization contribute to
each of the following risks, and thereby
financial crisis?
– Exchange rate risk
– Sudden stop or interest rate risk
– Moral hazard
Trouble
• Asian currencies pegged to dollar
• When dollar appreciated against yen, so did Asian
currencies
• Real estate prices fell, creating non-performing
loans
• Thai bank insolvent => panic throughout region
East & Southeast Asian economies
experienced dramatic declines
IMF Conditionality
(Oatley)
• Macroeconomic stabilization
– Tighter monetary policy
• Financial sector reform
– Close insolvent banks, recapitalize weak banks,
improve quality of financial intermediation
(including opening to foreign banks)
• Structural reform
– Trade liberalization, monopoly elimination, state
enterprise privatization
A positive and negative view of IMF
conditionality
• The IMF provides necessary technocratic
advice, and enables domestic governments to
accept that advice by restraining their policy
choices
• The IMF forces domestic governments to
adopt policies that are not necessarily helpful
(and sometimes destructive), based on the
preferences of policy makers in Washington
DC
Argentina introduced convertibility
(including currency board) to kill inflation
Domingo Cavallo
“a man of action”
15
Macroeconomic policy trilemma
“The Unholy Trinity”
Fixed exchange rate
Argentina dollarization
Capital mobility
Floating exchange rate
Monetary autonomy
16
Some pros and cons of “dollarization”
• Pros
– Low inflation
– Greater savings/investment (if capital believes
dollarization is credible)
• Cons
– Loss of monetary autonomy (interest rates set to
maintain peg)
– Reduced fiscal autonomy (deficits signal inflation)
17
Out with the old, in with the new
18
One source of foreign exchange was rapid privatization to foreign firms,
sometimes using unconstitutional emergency decrees
(Saba and Manzetti 1997)
19
Many firms repatriated profits, continuing pressure on the peso.
International crises & strong dollar forced Argentina to raise
interest rates to maintain peg, raising the cost of capital
20
The high cost of capital made borrowing expensive
The overvalued exchange rate made exports expensive
The economy shrank, the government adopted austerity budget
Depositors got nervous, began to pull money from banks
21
Democracy, Argentinian sovereignty, & hyperglobalization (e.g.,
total capital mobility) in conflict.
Something has to give…
Democratic politics
Hyperglobalization
“Golden Straitjacket”
Argentina dollarization
Nation state
22
Government limited withdrawals
Argentinians were not pleased
23
Dollarization abandoned, peso lost 75% of its value
Savings and purchasing power decimated
24
Argentinians were not pleased
25
Argentina’s Economic Collapse
http://www.youtube.com/watch?v=xMLVMEQm
hTQ&feature=related
26
Over time, lower borrowing costs & cheaper exports helped the
economy (in spite of default reputation costs) until the start of
the global financial crisis
27
Return to ISI policies
Major oil company (YPF) and Airline (Aerolineas Argentinas) nationalized
ISI policies and commodity prices enabled growth for
some time but it was unsustainable. Inflation, capital
flight, followed by new capital controls
29
Argentinians are not pleased
http://www.cnn.com/2012/11/08/world/americ
as/argentina-protests/index.html
30
UPDATE:
Argentina lost court decision to hedge funds
regarding default (Aug. 2013)
Argentinians continue to protest inflation, corruption,
and “unchecked presidential power” (Aug. 2013)
Nov. 22, 2015:
Opposition leader Mauricio Macri wins presidency
First non-Peronist president since 2001
Ability of countries to
accept/implement IMF conditions
varies
• Election timing
• Legislative constraint on the executive
(institutional veto players)
• Fragmented party systems (political veto
players)
• Party strength
• Dependence on foreign private finance
markets
Results
• Severe contraction in Turkey, Argentina, and
many Asian countries (but not Malaysia)
• High rise in poverty rates
• Political unrest
– Governments that borrowed from IMF paid the largest
political price – had to implement IMF-favored
policies that drastically cut government & social
spending
– E.g., Suharto falls in Indonesia
• Eventually robust growth returned
Critique of IMF response to Asian crisis
• Macroeconomic conditions were inappropriate for
Asian crisis
– Budget deficits & inflation were not a problem
– Austerity created deep recession
• Forced bank closures exacerbated fears, precipitated
panic
• Some structural adjustment moves were unnecessary
– “What [do] spice monopolies have to do with restoring
financial stability?”
• Other critics: IMF financial assistance in crisis creates
moral hazard for lending to governments
Results of IMF programs generally
(i.e., not just in Asia)
• No evidence that conditionality increased
growth (Stiglitz)
• Controlling for who receives IMF loans, IMF
loans have had a negative effect on growth
(Vreeland)
38
So why do governments accept IMF loans?
(Vreeland, Stiglitz)
• IMF programs
– Decrease GDP growth, and
– Decrease labor share of GDP, but
– Increase capital share of GDP
• Policies that favor capital over labor include
– Low inflation (central bank independence with
inflation mandate)
– Fiscal austerity
– Labor market deregulation/liberalization
39
Post-Asian Crisis Policy
Recommendations
• Capital controls on “hot money” reduce volatility
of financial flows with little harm to growth
• Banking reform, including transparency, reduces
risk
• Enhanced Structural Adjustment Facilities (ESAF)
replaced with Poverty Reduction and Growth
Facilities (PRGF) in 1999
– Less austerity, more government control &
participation (Poverty Reduction Strategy Papers) – at
least in theory
• 1996: HIPC
– Participatory process to write PRGF plan
– Selectivity (track record implementing plan)
instead of conditionality (promised policies)
– Debt forgiveness instead of restructuring
Changes in IMF policy
recommendations
• Move away from “one-size-fits-all” approach
• Move away from strict neo-liberal policies
– Fiscal stimulus recommended for most recent
financial crisis
– Capital controls can be beneficial (e.g., Iceland
case)
– Policies that decrease inequality decrease
volatility and increase long-term growth
42
Other Asian responses
• Chang Mai Initiative: Asian Monetary Fund to
replace role of IMF
• Bretton Woods II: Asian economies sought to
prevent future crises by accumulating large
stocks of reserves
– Sales to US drives accumulation
– New imbalance may have contributed to 20072009 crises
Asian countries made reforms that enabled
quick recovery from 2008 crisis
Source: Eder,
Grimm, & Steck
Conclusions
• High financial inflows (often short-term debt)
were a foundation for crisis in both 1970/80s
& 1990s
– 1970s/80s: Much was government borrowing
– 1990s: Much was private investment
• Fixed exchange rates lead to sustained
international imbalances
– 1970s/80s: ISI-based overvaluation
– 1990s: Pegs (crawling or fixed) to dollar
Conclusions
• Crises caused by both domestic and
international causes
– Domestic: Weak institutions allowing for
unproductive state enterprises or private bank
loans, etc.
– Foreign: Financial liberalization allows for high
volume inflows and then outflows/freeze
• Prevention of future crises may require both
reform (transparency, etc.) and reintroduction
of capital controls