Download ECON3315 – International Economic Issues

ECON3315
International Economic Issues
Instructor: Patrick M. Crowley
Issue 19: Financial Crises
Overview
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Types of financial crisis
Debt crises: what is the issue?
What happens in a financial crisis?
Approaches
Historical perspective
Reputation effects
Types of financial crisis
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Debt crises
Speculative bubbles and crashes
International financial crises
Each has a different effect, and can have
limited “country-wide” impact (e.g. Finnish
banking crisis of 1992) or can be
international in nature (e.g. South East
Asian crisis)
Debt crisis: what is the issue?
 The issue is that countries sometimes spend beyond their
means and end up not being able to pay their debts.
 These are known as “sovereign debts” and as a country
cannot go bankrupt (all debts from any government are
automatically inherited by the next government), should
there be some way to deal with this on an international
level?
 Why? Because if a crisis is allowed to happen, it can often
lead to contagion and regional instability and might even
cause a regional collapse in economic confidence.
 Access to international capital markets allows countries to
borrow. International capital markets assess a country’s
ability to pay back on macroeconomic performance, so this
is key here.
What happens in a debt crisis?
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Bonds are the sovereign debt of a country
When countries no longer have the funds to pay
interest on their bonds, a “default” occurs
Usually the lenders get together and go to the
country to negotiate a “debt restructuring” which
sometimes lowers interest rates so a payment can
be made, sometimes agrees upon a future debt
repayment schedule. These lenders are usually
known as “clubs”.
Usually an economic crisis occurs at the same time
so the IMF is heavily involved, and so economic
reforms are expected
Once the IMF is happy and releases funds, usually
private funds begin to flow back to the country and
lending resumes
Approaches ameliorating debt crises
Several different approaches have been made to
solving this problem in the literature:
i) Introduce a “Chaper 11” bankruptcy type
process for countries (Anne Krueger)
ii) Allow the IMF to operate as an international
“lender of last resort” (Barry Eichengreen)
iii) Capital controls and flexible exchange rates
(Jeffrey Sachs)
Debt crises: an historical perspective – the
usual suspects?
Many countries are “serial defaulters” – that is, they have
defaulted many times
 Brazil has defaulted on it’s debt 7 times over the past
175 years
 Venezuela has defaulted on it’s debt 9 times over the
past 175 years
 Some countries have only ever defaulted once, and
many developing countries have never defaulted on their
debts.
 But looking further back in time things were very
different…
Not necessarily the “usual suspects”!
Reputation effects
Interestingly, if you think that Brazil and Argentina
and Columbia have extremely high debts to begin
with, you’d be wrong…
 In 2001 when Argentina defaulted, its debt/GDP
level was only 52%, less than the level the US
debt/GDP level is forecast to be for 2009
 Currently Japan has extremely high debt/GDP
levels, and yet there is no talk of default…why?
 Seems to be reputation effect at work, and this is
why serial offenders common…you either default a
lot, or not at all.
 Clearly costs of defaulting for the first time are
significant, and once default occurs, likely that
international capital markets will not lend to you as
freely again
Reputation effects
Surprising result here, as no linear relationship
between debt to GDP at all….
So what is going on here?
Seems to be 3 groups at play…and reputation
clearly matters….
Speculative bubbles
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Dutch tulip bulb bubble in the 1700s was first
known speculative bubble
Idea is that if people know that other people
expect prices to go up, then prices will rise in a
self-reinforcing way, until the bubble bursts and
you get a “crash”
Experimental economics shows that these bubbles
occur even with small numbers of traders – seems
to be behavioral
Sometimes also known as “herd behaviour” or
“bandwagon effects”
Examples are Great crash (USA), Late 2000s
internet stockmarket bubble (USA), oil prices in
summer of 2008, and UK and some US housing
markets in recent years
Financial crises
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Presentation