Chapter 12 Flashcards
What are the types of crisis?
Banking
Currency
Debt
BoP
What is the banking crisis?
Banking system cannot perform its main function - they engage in intermediation and in a crisis there is disintermediation
H/H lose access to credit
What is intermediation?
Banks pool the savings of h/h and make them available to businesses
What is the currency crisis?
Sudden large collapse in the exchange rate
What are downsides of the currency crisis?
Loss of confidence in the economy - steep recession
Loss of outside financing and immediate need to eliminate currency account deficit
Increased unemployment
What is the debt crisis?
Sovereign default is gov cannot pay its debt
Can be internal or external
Leads to restructuring of the debt rather than complete repudiation
What is the BoP crisis?
Current account deficit cannot be financed
What are crisis vulnerabilities?
Economic conditions that make a country vulnerable to crisis
- economic imbalance
- volatile capital flow
What are crisis triggers?
Events that trigger a crisis
What is economic imbalance?
Unsustainable gov deficit
Large private debt level
Large current account deficit
Overvalued currency
What are volatile capital flows?
Financial capital can shift from one market to another - pressure on exchange rates
What is contagion?
Crisis remain domestic but some become international
Sources:
Direct linkages - banks, etc. are tied to US housing market
Wake up calls - one country experiences problems, signals that similar countries could have it
Common economic fundamentals - factors affecting a country has a similar negative impact elsewhere
What is not easy to follow in crisis prevention?
Credible monetary/fiscal policies
Avoid overvalued exchange rates
Active supervision and regulation of financial system
Timely information of interest to international investors
What are problems in crisis prevention?
MECC
Moral hazard
Exchange rate policy
Capital requirements
Capital control
Why is moral hazard a problem for crisis prevention?
- there is a large incentive to keep credit flowing and avoid a collapse in the banking system
- bailouts may encourage firms to take excessive risks and increase probability of future crisis
What are capital requirements in crisis prevention?
Banks should increase capital requirements - retained earnings, shareholder’s equity and bank reserves
What is exchange rate policy in crisis prevention?
Must be credible and sustainable:
Countries avoid real appreciation due to inflation
What are capital controls in crisis prevention?
Restrictions on the movement of capital into/out of the country
What can we say about the international capital flow regulations from the Asian Crisis of 1997?
Countries that were affected the most had large CA deficits and inflows made economies vulnerable to sudden reversals - capital flight
What can we say about the exchange rate management from the Asian Crisis of 1997?
Many currencies were pegged to the dollar and when it appreciated, so did exchange rates - currency misalignments
Harder to sustain
What can we say about the weak financial sector from the Asian Crisis of 1997?
Loss of export revenue
As firms grow, lack of disclosure made it difficult for outside lenders to assess risks of lending
Difficult to implement regulations needed for stability
What can we say about the international capital flow regulations from the Global Crisis of 2007?
Lack of regulation for cross-border financial products - securitized assets were sold globally without buyers knowing the risk - spread internationally
What can we say about the exchange rate management from the Global Crisis of 2007?
Flexible exchange rates were the norm but it did not insulate economies and post asian crisis affected the exchange rates
