Working Paper: NBER ID: w10907
Authors: Jeffrey A. Frankel; Shangjin Wei
Abstract: This study reviews broadly the experience of the last decade on crisis prevention and management. It seeks to draw greater attention to policy decisions that are made during the phase when capital inflows come to a sudden stop. Procrastination---the period of financing a balance of payments deficit rather than adjusting---had serious consequences in some cases. Crises are more frequent and more severe when short-term borrowing and dollar denomination external debt are high, and foreign direct investment (FDI) and reserves are low, in large part because balance sheets are then very sensitive to increases in exchange rates and short-term interest rates. If countries that are faced with a fall in inflows adjusted more promptly, rather than stalling for time by running down reserves or shifting to loans that are shorter-termed and dollar-denominated, they might be able to adjust on more attractive terms.
Keywords: macroeconomic crises; crisis prevention; crisis management; emerging markets
JEL Codes: F3; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| absence of corruption (H57) | better performance during financial turmoil (E44) |
| composition of capital inflows (F21) | severity of crises (H12) |
| higher levels of short-term external debt relative to reserves (F34) | higher susceptibility to currency crises (F31) |
| high inflation rates (E31) | higher probability of experiencing a currency crisis (F31) |
| delay in necessary adjustments during balance of payments difficulties (F32) | worse crisis outcomes (H12) |
| prompt adjustments (Y60) | less output loss during crises (H12) |
| combination of high short-term debt to reserves and elevated inflation (F34) | higher crisis probabilities (H12) |