Financial crises Lessons from the last 120 years

The crisis problem is one of the dominant macroeconomic features of our age. Its prominence suggests questions like the following: Are crises growing more frequent? Are they becoming more disruptive? Are economies taking longer to recover? These are fundamentally historical questions, which can be answered only by comparing the present with the past. To this end, this paper develops and analyses a data base spanning 120 years of financial history. We find that crisis frequency since 1973 has been double that of the Bretton Woods and classical gold standard periods and is rivalled only by the crisis‐ridden 1920s and 1930s. History thus confirms that there is something different and disturbing about our age. However, there is little evidence that crises have grown longer or output losses have become larger. Crises may have grown more frequent, in other words, but they have not obviously grown more severe. Our explanation for the growing frequency and chronic costs of crises focuses on the combination of capital mobility and the financial safety net, including the implicit insurance against exchange risk provided by an ex ante credible policy of pegging the exchange rate, which encourages banks and corporations to accumulate excessive foreign currency exposures. We also provide policy recommendations for restoring stability and growth.

— Michael Bordo, Barry Eichengreen, Daniela Klingebiel and Maria Soledad Martinez‐Peria

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Is the crisis problem growing more severe

https://www.bancaditalia.it/pubblicazioni/temi-discussione/1998/1998-0343/tema_343_98.pdf

What Caused the Asian Currency and Financial Crisis

This paper analyzes the drivers of international waves in capital flows. We build on the literature on “sudden stops” and “bonanzas” to develop a new methodology for identifying episodes of extreme capital flow movements using quarterly data on gross inflows and gross outflows, differentiating activity by foreigners and domestics. We identify episodes of “surge”, “stop”, “flight”, and “retrenchment” and show how our approach yields fundamentally different results than the previous literature that used measures of net flows. Global factors, especially global risk, are the most important determinants of these episodes. Contagion, especially through trade and the bilateral exposure of banking systems, is important in determining stop and retrenchment episodes. Domestic macroeconomic characteristics are generally less important, although changes in domestic economic growth influence episodes caused by foreigners. We find little role for capital controls in reducing capital flow waves. The results help provide insights for different theoretical approaches explaining crises and capital flow volatility.

Capital Flow Waves: Surges, Stops, Flights and Retranchment

The evidence from Sudden Stops in emerging economies shows that financial crashes are generally followed by major economic crises. This paper explains this phenomenon as an equilibrium outcome of a business cycle model with an endogenous collateral constraint that induces amplification and asymmetry in the responses of macro-aggregates to shocks. Cyclical dynamics produce economic expansions during which the ratio of debt to asset values raises enough to hit the constraint, triggering a Fisherian deflation that causes a spiraling decline in credit and in the price and quantity of collateral assets. Output and factor allocations also fall because the collateral constraint cuts access to working capital financing. In the long run, precautionary saving makes Sudden Stops low probability events nested within normal cycles, as observed in the data.

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Sudden Stops, Financial Crises, and Leverage

A key precursor of twentieth-century financial crises in emerging and advanced economies alike was the rapid buildup of leverage Those emerging economies that avoided leverage booms during the 2000s also were most likely to avoid the worst effects of the twenty-first century’s first global crisis A discrete-choice panel analysis using 1973-2010 data suggests that domestic credit expansion and real currency appreciation have been the most robust and significant predictors of financial crises, regardless of whether a country is emerging or advanced For emerging economies, however, higher foreign exchange reserves predict a sharply reduced probability of a subsequent crisis

Stories of the Twentieth Century for the Twenty-First

This paper studies sharp reductions in current account deficits and large exchange rate depreciations in low- and middle-income countries. It examines which factors help predict the occurrence of a reversal or a currency crisis, and how these events affect macroeconomic performance. It finds that both domestic factors, such as the low reserves, and external factors, such as unfavorable terms of trade and high interest rates in industrial countries, trigger reversals and currency crises. The two types of events are, however, distinct; indeed, current account imbalances are not sharply reduced in the years following a currency crisis. Economic performance around these events is also quite different. An exchange rate crash is associated with a fall in output growth and a recovery thereafter, while for reversal events there is no systematic evidence of a growth slowdown.

http://www.tau.ac.il/~razin/mfr.crisnber.pdf

Current Account Reversals and Currency Crises: Empirical Regularities

This paper puts forward a notion of current account sustainability that explicitly takes into account willingness to pay and willingness to lend in addition to intertemporal solvency. It argues that this notion of sustainability provides a better framework for understanding the variety of country experiences with protracted current account imbalances. Based on this notion, we identify a number of operational indicators related to the structure of the economy, the economic policy stance, and political economy factors. We use these sustainability indicators to evaluate the experience of a number of countries that ran persistent current account imbalances, and derive policy implications consistent with our notion of sustainability.

Sustainability of Persistent Current Account Deficits

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A number of developing countries have run large and persistent current account deficits in both the late seventies/early eighties and in the early nineties, raising the issue of whether these persistent imbalances are sustainable. This paper puts forward a notion of current account sustainability and compares the experience of three Latin American countries-Chile, Colombia Mexico-and three East Asian countries-Korea, Malaysia and Thailand. It identifies a number of potential sustainability indicators and discusses their usefulness in predicting external crises.

/pdf/current-account-sustainability-selected-east-asian-and-latin-1e341iw081.pdf

Gian Maria Milesi-Ferrett

Papers

Current Account Reversals and Currency Crises: Empirical Regularities

Sustainability of Persistent Current Account Deficits

Sustainability of Persistent Current Account Deficits

Current account sustainability : selected East Asian and Latin American experiences

Sustainability of Persistent Current Account Deficits