TÀI CHÍNH QUỐC TẾ 11 crisis

XI Currency Crisis and Debt Crisis TS Nguyễn Phúc Hiền - ðại học Ngoại thương Outline Currency Crisis First Generation Crisis Models Second Generation Crisis Models Third Generation Crisis Models Transmission Channels and Contagion Economic Policy Implications International Debt Crisis TS Nguyễn Phúc Hiền - ðại học Ngoại thương Currency Crisis Concept • A currency crisis is an economic crisis, which triggered by a sudden devaluation of a free floating currency or by the collapse of an exchange rate peg (as a consequence of speculative attacks) • A currency crisis is often linked to bursting bubbles, financial crisis and economic crises • The history of economic, currency, and financial crises is as old as capitalism itself - England 1720 South Sea Bubble - Germany 1873 real estate, railway - The US 1929 stocks (end of the post war boom) TS Nguyễn Phúc Hiền - ðại học Ngoại thương Currency Crisis Characteristics of Currency Crisis • Crises are often linked to positive expectation and the influx of liquidity • Financial and banking crises: collapse of the banking sector or the financial system • Currency and balances of payments crises: speculative attacks against at exchange rate peg, which subsequently collapses • Strong volatilities in markets • Stock and real estate markets sink • Large exchange rate fluctuations TS Nguyễn Phúc Hiền - ðại học Ngoại thương First Generation Crisis Models Krugman (1979) Flood Garber (1984) reasons • Unsound fundamentals (BWS, Latin America) • Unsustainable economic policies Characteristics of the crisis • Structural deficits are monetarized • Strong growth of money supply • Increasing inflation • Rising current account deficits • Speculative attacks against the peg • Loss of foreign reserves TS Nguyễn Phúc Hiền - ðại học Ngoại thương First Generation Crisis Models Crisis • When foreign reserves are depleted or the losses are too large, this causes the central bank to release the peg • The devaluation destabilizes the financial sector • Collapse of BWS (1970s) and Latin America TS Nguyễn Phúc Hiền - ðại học Ngoại thương Second Generation Crisis Models Obstfeld (1986) va (1994) reasons: • Psychological factors (multiple equilibria) EMS crisis • Credibility of economic policy Characteristics of the crisis • Political trade-off between fixed exchange rate and a expansionary monetary policy (growth and employment) • Investors assume the priority of domestic employment • Reversal of capital inflows triggers and interest rate increase, which again endangers employment • Exchange rate peg loses its credibility Crisis • The crisis is triggered by expections of the financial markets (speculation against the Bank of England) • The crisis is fundamentally unjustified TS Nguyễn Phúc Hiền - ðại học Ngoại thương Third Generation Crisis Models Krugman (1998) Corsetti/Pesenti/Roubini (1999) • Sound fundamentals • But with incentives for speculative investment • Weak financial system and banking sector Characteristics of the crisis • Excessive availability of foreign capital (capital inflow) (overborrowing) • Excessive credit growth (overlending) • Due to implicit public guarantees, potential exchange rate risk is ignored (moral hazard) • Speculative bubbles in equity and real estate markets emerge TS Nguyễn Phúc Hiền - ðại học Ngoại thương Third Generation Crisis Models Crisis • Withdrawal of international capital results in bursting bubbles and the devaluation of the domestic currency • The currency denomination of foreign credit and term transformation worsen the crisis • The Asia Financial Crisis 1997 TS Nguyễn Phúc Hiền - ðại học Ngoại thương Moral Hazard and Overinvestment Concept • Moral hazard arise because an individual or institution does not bear the full consequences of its actions, • and therefore has a tendency to act less carefully than it otherwise would, • Leaving another party to bear some responsibility for the consequences of those actions TS Nguyễn Phúc Hiền - ðại học Ngoại thương 10 Moral Hazard and Overinvestment Moral hazard and currency crisis • A fixed exchange rate can suggest that there will be no currency risk in the future, even if a higher interest level suggest a devaluation • In case of crisis, the emerging markets‘ banking sector are bailed out by IMF, which is anticipated • Implicit guarantees and ignorance of currency risk contributes to exessive international borrowing and lending • This leads to overinvestment TS Nguyễn Phúc Hiền - ðại học Ngoại thương 11 Transmission Channels and Contagion Usually a crisis does not remain limited to one country, there are several transmission channels Spillovers • In economically integrated markets • Imports of the crisis country decline (goods market channel) • Loans from other countries are defaulting (asset market channel) • Even in economically not integrated countries • Whose fundamentals data suffer from weaknesses • A reassessment of fundamentals take place (new risk evaluation) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 12 Economic Policy Implication Flexible instead of fixed exchange rates (Fisher 2001) • Since currency crises often happened in countries with exchange rate pegs (soft pegs), the IMF supports floating exchange rates in emerging markets to deter speculative capital inflows • Emerging markets with fully flexible exchange rates have to deal with strong appreciations and thereby lower real growth in face of strong capital inflows • Officially, many East Asia countries moved towards flexible exchange rates, unofficially there is still a strong tendency to stabilize exchange rates (fear of floating) • Most countries returned to so-called soft pegs (managed floats) TS Nguyễn Phúc Hiền - ðại học Ngoại thương 13 International Debt Crisis • • • • • Concept Characteristics of debt crisis Background and origins of the debt crisis The emergence of the debt crisis The management of the debt crisis TS Nguyễn Phúc Hiền - ðại học Ngoại thương 14 ... Currency Crisis First Generation Crisis Models Second Generation Crisis Models Third Generation Crisis Models Transmission Channels and Contagion Economic Policy Implications International Debt Crisis. .. International Debt Crisis • • • • • Concept Characteristics of debt crisis Background and origins of the debt crisis The emergence of the debt crisis The management of the debt crisis TS Nguyễn... Second Generation Crisis Models Obstfeld (1986) va (1994) reasons: • Psychological factors (multiple equilibria) EMS crisis • Credibility of economic policy Characteristics of the crisis • Political