Econometric policy evaluation: A critique

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

This article proposes a new approach to evaluate contagion in financial markets. Our measure of contagion captures the coincidence of extreme return shocks across countries within a region and across regions. We characterize the extent of contagion, its economic significance, and its determinants using a multinomial logistic regression model. Applying our approach to daily returns of emerging markets during the 1990s, we find that contagion is predictable and depends on regional interest rates, exchange rate changes, and conditional stock return volatility. Evidence that contagion is stronger for extreme negative returns than for extreme positive returns is mixed.

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A new approach to measuring financial contagion

Many observers have argued the regulatory framework in place prior to the global financial crisis was deficient because it was largely “microprudential” in nature (Crockett, 2000; Borio, Furfine, and Lowe, 2001; Borio, 2003; Kashyap and Stein, 2004; Kashyap, Rajan, and Stein, 2008; Brunnermeier et al., 2009; Bank of England, 2009; French et al., 2010). A microprudential approach is one in which regulation is partial-equilibrium in its conception, and aimed at preventing the costly failure of individual financial institutions. By contrast, a “macroprudential” approach recognizes the importance of general-equilibrium effects, and seeks to safeguard the financial system as a whole. In the aftermath of the crisis, there seems to be agreement among both academics and policymakers that financial regulation needs to move in a macroprudential direction. According to Federal Reserve Chairman Ben Bernanke (2008): Going forward, a critical question for regulators and supervisors is what their appropriate "field of vision" should be. Under our current system of safety-and-soundness regulation, supervisors often focus on the financial conditions of individual institutions in isolation. An alternative approach, which has been called systemwide or macroprudential oversight, would broaden the mandate of regulators and supervisors to encompass consideration of potential systemic risks and weaknesses as well.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1708173_code753937.pdf?abstractid=1708173&mirid=2

A Macroprudential Approach to Financial Regulation

In recent decades, developments in the financial sector have played a major role in shaping macroeconomic outcomes in a wide range of countries. Financial developments have reinforced the momentum of underlying economic cycles, and in some cases have led to extreme swings in economic activity and a complete breakdown in the normal linkages between savers and investors. These experiences have led to concerns that the financial system is excessively procyclical, unnecessarily amplifying swings in the real economy. In turn, these concerns have prompted calls for changes in prudential regulation, accounting standards, risk measurement practices and the conduct of monetary policy in an attempt to enhance both financial system and macroeconomic stability.

Procyclicality of the financial system and financial stability: Issues and policy options

Ever since the ERM crises of 1992-93 and the Mexican crisis of 1994-95, there has been a heightened interest in early-warning signals of financial crises. This study reviews the literature on the origins of currency and banking crises. It then presents a comprehensive battery of empirical tests on the performance of alternative early-warning indicators for emerging-market economies. The study identifies crisis-threshold values for early-warning indicators that differ both by country and by indicator. This allows the authors to make historical comparisons among banking or currency crises, as well as to draw conclusions about which specific indicators have, over time, sent the most reliable early-warning signals of future currency or banking crises in emerging markets.

Assessing Financial Vulnerability: An Early Warning System for Emerging Markets

A summary of what we know about the origins of currency mismatching in emerging economies. It discusses how best to define and measure currency mismatching and reviews policy options for reducing the size of the problem.

Controlling Currency Mismatches in Emerging Markets

This paper looks at banking crises in the developing world. It discusses eight major types of cause, including both macroeconomic and supervisory factors. It discusses policy options, drawing on actual experience in developing and developed economies. Contains international statistical comparisons.

https://papers.ssrn.com/sol3/Delivery.cfm?abstractid=52074

Banking crises in emerging economies: Origins and policy options

In most of the currency crises of the 1990s, the largest output falls have occurred in those emerging economies with large currency mismatches, a phenomenon that occurs when assets and liabilities are denominated in different currencies such that net worth is sensitive to changes in the exchange rate. Currency mismatching makes crisis management much more difficult since it constrains the willingness of the monetary authority to reduce interest rates in a recession (for fear of initiating a large fall in the currency that would bring with it large-scale insolvencies). The mismatching also produces a "fear of floating" on the part of emerging economies, sometimes inducing them to make currency-regime choices that are not in their own long-term interest.

This text explores the volatile nature of private capital flows. It covers: the 1994 Mexican crisis; emerging markets after the crisis; borrowing in international capital markets; policy responses to surges in capital inflows; explaining the crisis; and preventing future crises.

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Morris Goldstein

Papers

Assessing Financial Vulnerability: An Early Warning System for Emerging Markets

Controlling Currency Mismatches in Emerging Markets

Banking crises in emerging economies: Origins and policy options

Controlling Currency Mismatches in Emerging Markets

Private capital flows to emerging markets after the Mexican crisis