Managing Currency Crises in Emerging Markets
edited by Michael P. Dooley and Jeffrey A. Frankel
University of Chicago Press, 2003
Cloth: 978-0-226-15540-1 | Electronic: 978-0-226-15542-5
DOI: 10.7208/chicago/9780226155425.001.0001
ABOUT THIS BOOKAUTHOR BIOGRAPHYTABLE OF CONTENTS

ABOUT THIS BOOK

The management of financial crises in emerging markets is a vital and high-stakes challenge in an increasingly global economy. For this reason, it's also a highly contentious issue in today's public policy circles. In this book, leading economists-many of whom have also participated in policy debates on these issues-consider how best to reduce the frequency and cost of such crises.

The contributions here explore the management process from the beginning of a crisis to the long-term effects of the techniques used to minimize it. The first three chapters focus on the earliest responses and the immediate defense of a currency under attack, exploring whether unnecessary damage to economies can be avoided by adopting the right response within the first few days of a financial crisis. Next, contributors examine the adjustment programs that follow, considering how to design these programs so that they shorten the recovery phase, encourage economic growth, and minimize the probability of future difficulties. Finally, the last four papers analyze the actual effects of adjustment programs, asking whether they accomplish what they are designed to do-and whether, as many critics assert, they impose disproportionate costs on the poorest members of society.

Recent high-profile currency crises have proven not only how harmful they can be to neighboring economies and trading partners, but also how important policy responses can be in determining their duration and severity. Economists and policymakers will welcome the insightful evaluations in this important volume, and those of its companion, Sebastian Edwards and Jeffrey A. Frankel's Preventing Currency Crises in Emerging Markets.

AUTHOR BIOGRAPHY

Michael P. Dooley is a professor of economics at the University of California, Santa Cruz. He is also a research associate of the National Bureau of Economic Research and the managing editor of the International Journal of Finance and Economics.

Jeffrey A. Frankel is the James W. Harpel Professor of Capital Formation and Economic Growth at Harvard University's Kennedy School of Government and the director of the National Bureau of Economic Research's program in International Finance and Macroeconomics. He is the coauthor, most recently, of American Economic Policy in the 1990s.

TABLE OF CONTENTS

Acknowledgments

- Michael P. Dooley, Jeffrey A. Frankel
DOI: 10.7208/chicago/9780226155425.003.0001
[currency crises, emerging markets, adjustment programs, crises management]
This chapter discusses the contents of this volume, which is about management of currency crises in emerging markets. The collection of papers in this volume were presented at a National Bureau of Economic Research Conference, held in Monterey, California in March 2001. This volume is divided into three parts which can be seen as three phases counting forward from the moment that a country is hit by a crisis. The first part describes the immediate defense of the currency regime under attack, the second examines the adjustment programs that follow crises and the third evaluates the effectiveness of the adjustment programs. (pages 1 - 8)
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I. The Defense

- Dongchul Cho, Kenneth D. West
DOI: 10.7208/chicago/9780226155425.003.0003
[exchange rates, interest rates, exchange rate crises, Korea, Philippines, Thailand, monetary policy reaction function, interest parity equation]
This chapter examines the relationship between exchange rates and interest rates during the 1997–98 exchange rate crises in Korea, the Philippines and Thailand. It aims to determine whether exogenous monetary-policy-induced increases in the interest rate in these economies cause exchange rate depreciation or appreciation. This chapter proposes a two-equation model for exchange rates and interest rates which include a monetary policy reaction function and an interest parity equation. It explains that increases in interest rates following crises led to exchange rate appreciation in Korea and the Philippines but to depreciation in Thailand. (pages 11 - 30)
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Comment

Discussion Summary

- Allan Drazen
DOI: 10.7208/chicago/9780226155425.003.0004
[interest rate, currency system, exchange rate, government, speculators]
This chapter deals with an interest rate defense against a speculative attack on a currency regime. It argues that a major effect of high interest rates is to signal the government's willingness or ability to defend the exchange rate against a potential crisis. It explores a class of models in which an interest rate defense alters the speculators' views of the type of government they face, introduces an alternative way of defending a currency system and considers the information an interest rate defense conveys about the ability of a government to defend. (pages 37 - 54)
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Discussion Summary

- Barry Eichengreen, Andrew K. Rose
DOI: 10.7208/chicago/9780226155425.003.0005
[pegged exchange rates, economic growth, gross national product, output losses, open economies]
This chapter compares the behavior of failed and successful defenses of pegged exchange rates. It shows that the costs of unsuccessful defense against an attack on a currency system are large, about one year of economic growth or three percent of gross national product. The analysis also reveals that the difference in output losses between successful and unsuccessful defense is only significant for just one year. This finding can help account for a number of observations about the behavior of open economies and their policy makers. (pages 61 - 82)
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II. The Program

- Olivier Jeanne, Charles Wyplosz
DOI: 10.7208/chicago/9780226155425.003.0006
[ILOLR, international financial architecture, emerging economy, liquidity crises, domestic banks, liquidity gap]
This chapter examines whether an international lender of last resort (ILOLR) would be a useful addition to the international financial architecture. It analyzes whether an ILOLR can function effectively as a fund with limited and predetermined resources using a model of an emerging economy vulnerable to international liquidity crises. The findings reveal that required size of the ILOLR depends on how its resources are used by the domestic authorities. This chapter explains that if the LOLR backs a guarantee of the foreign currency liabilities of domestic banks, its resources do not need to be larger than the liquidity gap in the domestic banking sector. (pages 89 - 118)
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Discussion Summary

- Michael P. Dooley, Sujata Verma
DOI: 10.7208/chicago/9780226155425.003.0007
[rescue packages, output losses, exchange rate crisis, IMF, insurance model, capital inflows]
This chapter deals with rescue packages and output losses following an exchange rate crisis. It analyzes the role of International Monetary Fund (IMF) in a game theoretic context and investigates why there are large output losses post-crisis. This chapter evaluates rescue packages in the context of an explicit model of crises and argues that the insurance model is an attractive vehicle for the analysis because it provides an explanation for surges in capital inflows followed by sudden stops. (pages 125 - 141)
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- Stijn Claessens, Daniela Klingebiel, Luc Laeven
DOI: 10.7208/chicago/9780226155425.003.0008
[financial restructuring, banking sector, corporate sector, liquidity support, asset management corporation, financial crisis, government guarantees]
This chapter reviews knowledge about the trade-offs involved in policies related to financial restructuring in banking and corporate sector crises. It examines a micro dataset for 700 companies in nine crisis countries to determine policies that are important in minimizing the cost of the crises. The analysis reveals that liquidity support early in the crisis and the use of a government-run asset management corporation can mitigate the severity of a financial crisis while government guarantees of the banking system's financial liabilities do not appear to be helpful. (pages 147 - 180)
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- A. Craig Burnside, Martin Eichenbaum, Sergio Rebelo
DOI: 10.7208/chicago/9780226155425.003.0009
[twin crises, inflation, currency depreciation, Korea, Mexico, government deficits, fiscal reforms]
This chapter examines the implications of different strategies for financing the fiscal costs of the twin crises of inflation and currency depreciation in Mexico and Korea in the 1990s using a model in which a currency crisis is triggered by prospective government deficits. It explains the features and capabilities of this model. The analysis reveals that the Mexican government will likely pay for most of the fiscal cost of its crisis by printing money while the Korean government is likely to do so via a mixture of future implicit and explicit fiscal reforms. (pages 187 - 222)
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- Morris Goldstein
DOI: 10.7208/chicago/9780226155425.003.0015
[international financial architecture, financial reform, IMF, interest rate, policy conditionality, currency mismatching, hedging]
This chapter evaluates several proposals for the reform of the international financial architecture using the lending policies and practices of the International Monetary Fund (IMF) as an organizing device for discussing selected issues in the reform debate. These include proposals to increase the interest rate or reduce the maturity of IMF loans, to restrict the size of IMF rescue packages and to replace ex post macroeconomic policy conditionality of the IMF. The analysis reveals that proposals for addressing currency mismatching problems appear to be either too costly or too drastic. This chapter suggests a combination of managed floating and active development of hedging mechanisms. (pages 225 - 262)
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III. The Impact

- Yung Chul Park, Jong-Wha Lee
DOI: 10.7208/chicago/9780226155425.003.0010
[macroeconomic adjustment, financial crisis, East Asia, gross domestic product, V-pattern of adjustment]
This chapter examines the macroeconomic adjustment following the 1997 financial crisis in East Asia from a broad international perspective. It evaluates the impacts of the crisis on gross domestic product growth using a cross-country data set and identifies the critical factors that determine the adjustment process. The analysis reveals GDP growth rates drop with the eruption of a crisis but then recover quickly to the pre-crisis level in two or three years, showing a V-pattern of adjustment. This chapter also investigates the internal and external factors responsible for the deeper crisis and the quicker recovery in East Asia. (pages 275 - 316)
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Discussion Summary

- Michael M. Hutchison
DOI: 10.7208/chicago/9780226155425.003.0011
[stabilization programs, IMF, currency crisis, balance-of-payment crisis, gross domestic product, output loss, East Asia]
This chapter examines the output costs of participating in International Monetary Fund (IMF)-supported stabilization programs following a currency or balance-of-payment crisis. The analysis of the 1997 East Asian crisis reveals that participation in an IMF program is associated with a 0.75 percentage point reduction in gross domestic product growth and that participation in an IMF-supported program following a balance-of-payments or currency crisis does not appear to mitigate the output loss associated with such events. The study also found that the country that did not have an IMF program suffered more than those countries with programs. (pages 321 - 358)
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- William Easterly
DOI: 10.7208/chicago/9780226155425.003.0012
[structural adjustment programs, poverty reduction, IMF, World Bank, economic growth, poor people]
This chapter examines the impact of the structural adjustment programs of the International Monetary Fund (IMF) and the World Bank on poverty reduction. It argues that structural adjustment, measured by the number of adjustment loans from the IMF and World Bank, reduces the sensitivity of poverty reduction to the rate of growth. Economic growth does reduce poverty but there is no evidence for a direct effect of structural adjustment on the average rate of growth. In fact, the poor benefit less from output expansion in countries with many adjustment loans than in countries with few. (pages 361 - 382)
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- James Levinsohn, Steven Berry, Jed Friedman
DOI: 10.7208/chicago/9780226155425.003.0013
[economic crisis, poor people, Indonesia, cost of living, urban households, rural households]
This chapter evaluates the impact of the 1997 economic crisis on the poor people in Indonesia. The analysis reveals that price increases have affected the cost of living of poor households disproportionally; the effects differ in urban and rural households. This chapter argues that that the notion that the very poor are so poor as to be insulated from international shocks is simply wrong because it was the poor in the Indonesian case that appear to be the most vulnerable. (pages 393 - 424)
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Contributors

Author Index

Subject Index