Financial Crises, Liquidity, and the International Monetary System / Edition 1

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Overview

"In this remarkably ambitious and insightful book, Jean Tirole tackles the core issues in the economics of international lending with his usual superb clarity of thought. This book is essential reading to anyone interested in understanding the economics behind the recent drive to improve the international financial architecture."—Ken Rogoff, Chief Economist and Director of Research, International Monetary Fund

"Jean Tirole is living proof of the value of good economic thinking. He shines new light on, and dissipates heat from, every issue he touches. In this book he offers us an amazing combination of detailed facts and rigorous theory about international financial crises. His perspective of dual and common agencies enriches our understanding of the roles and shortcomings of international economic institutions, and points the way to reform. All the supposed experts who engage in controversies on these matters should learn from this book."—Avinash Dixit, Princeton University

"This book presents one of the first comprehensive attempts to bring rigorous theoretical foundations into the debate on the international financial architecture. The analysis is simple, elegant, and yields insights that are often unconventional and always thought-provoking. This is an indispensable reference for all economists interested in the current debates on the international financial architecture."—Olivier Jeanne, International Monetary Fund

"Most proposals for reforming the international financial system derive from ad hoc explanations for recent crises. Jean Tirole goes back to first principles. He asks how relations between lenders and borrowers differ in the international context from those in the domestic context. You may not agree with all of his conclusions but will have to rethink your own views after you have read it."—Peter B. Kenen, Princeton University

"Jean Tirole uses the tools of corporate finance to analyse some key aspects of international finance. As we expect from him, we get deep and fruitful insights into issues such as borrower and lender behavior, the appropriate role of the IMF, and private sector involvement in orderly workouts. This is essential reading for all those concerned with the 'international financial architecture.'"—Richard Portes, London Business School

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Editorial Reviews

From the Publisher
"An insightful contribution to the expanding economics research that reexamines the role of the International Monetary Fund in emerging markets and financial crises."—Choice
Choice
An insightful contribution to the expanding economics research that reexamines the role of the International Monetary Fund in emerging markets and financial crises.
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Product Details

  • ISBN-13: 9780691099859
  • Publisher: Princeton University Press
  • Publication date: 7/1/2002
  • Edition description: New Edition
  • Edition number: 1
  • Pages: 128
  • Product dimensions: 5.68 (w) x 8.76 (h) x 0.74 (d)

Meet the Author

Jean Tirole is Scientific Director of the Institut d'Economie Industrielle (IDEI) at the University of Social Sciences in Toulouse, one of Europe's leading centers for the study of economics, and is also affiliated with Ecole des Ponts, Paris, and MIT. He is the author or coauthor of six books, including "The Theory of Industrial Organization", "Game Theory", "A Theory of Incentives in Regulation and Procurement", and "The Prudential Regulation of Banks". Tirole is a past president of the Econometric Society and the European Economic Association.
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Read an Excerpt

COPYRIGHT NOTICE: Published by Princeton University Press and copyrighted, © , by Princeton University Press. All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher, except for reading and browsing via the World Wide Web. Users are not permitted to mount this file on any network servers.

Introduction

A wide consensus had emerged among economists. Capital account liberalization—allowing capital to flow freely in and out of countries without restrictions—was unambiguously good. Good for the debtor countries, good for the world economy. The twofold case for capital mobility is relatively straightforward: First, capital mobility creates superior insurance opportunities and promotes an efficient allocation of investment and consumption. Capital mobility allows households and firms to insure against country-specific shocks in worldwide markets; households can thereby smooth their consumption and firms better manage their risks. Business cycles are dampened, improved liquidity management boosts investment and promotes growth. Second, besides insurance, capital mobility also permits the transfer of savings from low- to high-return countries. This transfer raises worldwide growth and further gives a chance to the labor force of low-income countries to live better. In these two respects, the increase in the flow of private capital from industrial to developing countries from $174 billion in the 1980s to $1.3trillion during the 1990s1 should be considered good news.

That consensus has been shattered lately. A number of capital account liberalizations have been followed by spectacular foreign exchange and banking crises.2 The past twenty years have witnessed large scale crises such as those in Latin America (early 1980s), Scandinavia (early 1990s), Mexico (1994), Thailand, Indonesia, and South Korea (1997), Russia (1998), Brazil (1998-9) and Argentina (2001), as well as many smaller episodes. The crises have imposed substantial welfare losses on hundreds of millions of people in those countries.

Economists, as we will discuss later, still strongly favor some form of capital mobility but are currently widely divided about the interpretation of the crises and especially their implications for capital controls and the governance of the international financial system. Are such crises just an undesirable, but unavoidable byproduct of an otherwise desirable full capital account liberalization? Should the world evolve either to the corporate model where workouts are a regular non-crisis event or to the municipal bond model where defaults are rare? Would a better sequencing (e.g., liberalization of foreign direct and portfolio investments and the building of stronger institutions for the prudential supervision of financial intermediaries before the liberalization of short-term capital flows) have prevented these episodes? Should temporary or permanent restrictions on short-term capital flows be imposed? How does this all fit with the choice of an exchange rate regime? Were the crises handled properly? And, should our international financial institutions be reformed?

This book was prompted by a questioning of my own understanding of its subject. Several times over recent years I have been swayed by a well-expounded and coherent proposal only to discover, with striking naivety, that I later found an equally eloquent, but inconsistent, argument just as persuasive. While this probably reflected lazy thinking on my part, I also came to wonder how it is that economists whom I respect very highly could agree broadly on the facts and yet disagree strongly on their implications.

I also realized that I was missing a ''broad picture''. An epitome for this lack of perspective relates to international institutions. I have never had a clear view of what, leaving aside the fight against poverty, the International Monetary Fund (IMF) and other international financial institutions (IFIs) were trying to achieve: avoid financial crises, resolve them in an orderly manner, economize on taxpayers' money, protect foreign investors, respect national sovereignty, limit output volatility, prevent contagion, facilitate a country's access to funds, promote long-term growth, force structural reforms—not to mention the IMF's traditional current account, international reserves and inflation objectives.3

This book is to some extent an attempt to go back to first principles and to identify a specific form of market failure, that will guide our thinking about crisis prevention and institutional design. Needless to say, I will be focusing on a particular take on the international financial system, which need not exclude other and complementary approaches. I believe, though, that the specific angle taken here may prove useful in clarifying the issues.

The book is organized as follows. Chapter 1 is a concise overview of recent crises and institutional moves for the reader with limited familiarity with the topic. Chapter 2 summarizes and offers a critique of economists' views on the subject. Chapter 3 provides a roadmap for our main argument. Basically, I suggest that international financing is similar to standard corporate financing except in two crucial respects, which I name the ''dual-agency problem'' and the ''common-agency problem''. Chapter 4 therefore provides the reader with a concise review of those key insights of corporate finance that are relevant for international finance. Chapter 5 describes the market failure. Chapter 6 draws its implications for crisis prevention and management. Chapter 7 investigates the lessons of the analysis for the design of international financial institutions.Finally, Chapter 8 summarizes and discusses routes for future research.



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Table of Contents

Acknowledgments vii
Introduction ix
1. Emerging Markets Crises and Policy Responses 1
The pre-crisis period 1
The crisis 7
IMF reforms, regulatory changes, and private sector innovations 18
2. The Economists' Views 23
Consensus view 23
Conflicting advice and the topsy-turvy principle 29
"Unrealistic" encroachments on sovereignty 36
Theories 36
3. Outline of the Argument and Main Message 47
The problem of a standard borrower 48
Why is external borrowing different? 48
Institutional and policy responses to market failure 50
4. Liquidity and Risk-Management in a Closed Economy 53
Corporate financing: key organizing principles 53
Domestic liquidity provision 70
5. Identification of Market Failure: Are Debtor Countries Ordinary Borrowers? 77
The analogy and a few potential differences 77
A dual-agency perspective 81
The government's incentives 86
Discussion 88
A common-agency perspective 92
6. Implications of the Dual- and Common-Agency Perspectives 97
Implication 1: the representation hypothesis 97
Implication 2: policy analysis 102
Cross-country comparisons 108
Is there a need for an international lender of last resort? 110
7. Institutional Implications: What Role for the IMF? 113
From market failure to mission design 113
Governance 116
8. Conclusion 129
References 131
Index 145

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Recipe

"In this remarkably ambitious and insightful book, Jean Tirole tackles the core issues in the economics of international lending with his usual superb clarity of thought. This book is essential reading to anyone interested in understanding the economics behind the recent drive to improve the international financial architecture."—Ken Rogoff, Chief Economist and Director of Research, International Monetary Fund

"Jean Tirole is living proof of the value of good economic thinking. He shines new light on, and dissipates heat from, every issue he touches. In this book he offers us an amazing combination of detailed facts and rigorous theory about international financial crises. His perspective of dual and common agencies enriches our understanding of the roles and shortcomings of international economic institutions, and points the way to reform. All the supposed experts who engage in controversies on these matters should learn from this book."—Avinash Dixit, Princeton University

"This book presents one of the first comprehensive attempts to bring rigorous theoretical foundations into the debate on the international financial architecture. The analysis is simple, elegant, and yields insights that are often unconventional and always thought-provoking. This is an indispensable reference for all economists interested in the current debates on the international financial architecture."—Olivier Jeanne, International Monetary Fund

"Most proposals for reforming the international financial system derive from ad hoc explanations for recent crises. Jean Tirole goes back to first principles. He asks how relations between lenders and borrowers differ in theinternational context from those in the domestic context. You may not agree with all of his conclusions but will have to rethink your own views after you have read it."—Peter B. Kenen, Princeton University

"Jean Tirole uses the tools of corporate finance to analyse some key aspects of international finance. As we expect from him, we get deep and fruitful insights into issues such as borrower and lender behavior, the appropriate role of the IMF, and private sector involvement in orderly workouts. This is essential reading for all those concerned with the 'international financial architecture.'"—Richard Portes, London Business School

Read More Show Less

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