Working Paper: NBER ID: w10845
Authors: Raghuram G. Rajan
Abstract: Emerging markets do not handle adverse shocks well. In this paper, we lay out an argument about why emerging markets are so fragile, and why they may adopt contractual mechanisms -such as a dollarized banking system- that increase their fragility. We draw on this analysis to explain why dollarized economies may be prone to dollar shortages and twin crises. The model of crises described here differs in some important aspects from what is now termed the first, second, and third generation models of crises. We then examine how domestic policies, especially monetary policy, can mitigate the adverse effects of these crises. Finally, we consider the role, potentially constructive, that international financial institutions may undertake both in helping to prevent the crises and in helping to resolve them.
Keywords: Dollarization; Banking Crises; Emerging Markets; Institutional Quality
JEL Codes: G15; G28; F21; F32; F34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| weak institutions (O17) | increased dollarization (F31) |
| increased dollarization (F31) | higher likelihood of banking crises (F65) |
| weak institutions (O17) | higher likelihood of banking crises (F65) |
| effective policy interventions (D78) | reduced severity of crises (H12) |
| banking system failures (F65) | economic downturns (F44) |