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The 1997-98 Liquidity Crisis: Asia versus Latin America

In: Banking, Financial Integration, and International Crises

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  • Roberto Chang

    (Rutgers University-New Brunswick)

  • Andrés Velasco

    (Ministerio de Hacienda, Gobierno de Chile)

Abstract

Several East Asian countries suffered a sudden stop, with massive and unexpected capital outflows, in 1997-98. Latin American countries, in spite of their more checketed financial past, were much less severely hit at the time (of course, several have had crises since). Why this asymmetry between the two regions? In this paper we argue that what saved Latin America in 1997-98 was not a stronger set of macroeconomic fundamentals (many Latin countries, for instance, had substantial real exchange rate appreciation and non-trivial current account deficits) but a stronger financial position. In contrast, the Asian countries were in a situation of international illiquidity evidenced by sharply rising ratios of hard currency short-term liabilities to liquid assets. As such, they were extremely vulnerable to a reversal of capital inflows, which occurred massively in the second half of 1997. Financial fragility in Asia had its roots in inappropriate microeconomic policies followed during previous years. As we document below, financial liberalization measures in Asia resulted in a deterioration of the international liquidity position of the financial system. These measures, carried out at a time of large capital inflows, created the conditions for a crisis. Much of the borrowing was in dollars and, especially in the period right before the crisis, short term. These two factors left domestic banks exposed to exchange risk and to the mood swings of lenders who had to roll over large loan volumes at short-intervals. By contrast the Latin countries, having gone through their cycle of financial liberalization and collapse in the 1980s and early 1990s, have followed much more cautious policies in recent years.

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Bibliographic Info

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This chapter was published in: Leonardo Hernández & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.) Banking, Financial Integration, and International Crises, , chapter 13, pages 413-452, 2002.

This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v03c13pp413-452.

Handle: RePEc:chb:bcchsb:v03c13pp413-452

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References

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  1. Diamond, Douglas W, 1997. "Liquidity, Banks, and Markets," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 928-56, October.
  2. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  3. Menzie D. Chinn, 1998. "Before the Fall: Were East Asian Currencies Overvalued?," NBER Working Papers 6491, National Bureau of Economic Research, Inc.
  4. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," Working Paper 97-16, Federal Reserve Bank of Atlanta.
  5. Rudger Dornbusch & Ilan Goldfajn & Rodrigo O. Valdés, 1995. "Currency Crises and Collapses," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 219-294.
  6. Guillermo A. Calvo & Enrique G. Mendoza, 1996. "Mexico's balance-of-payments crisis: a chronicle of death foretold," International Finance Discussion Papers 545, Board of Governors of the Federal Reserve System (U.S.).
  7. Corbo, Vittorio & Hernandez, Leonardo, 1994. "Macroeconomic adjustment to capital inflows : Latin American style versus East Asian style," Policy Research Working Paper Series 1377, The World Bank.
  8. George A. Akerlof & Paul M. Romer, 1993. "Looting: The Economic Underworld of Bankruptcy for Profit," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(2), pages 1-74.
  9. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
  10. Cardenas, Mauricio & Barrera, Felipe, 1997. "On the effectiveness of capital controls: The experience of Colombia during the 1990s," Journal of Development Economics, Elsevier, vol. 54(1), pages 27-57, October.
  11. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
  12. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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