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Market Discipline and Exuberant Foreign Borrowing

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  • Eduardo Fernández-Arias
  • Davide Lombardo

Abstract

Recent crises in emerging markets call into question the effectiveness of market discipline for ensuring efficient foreign borrowing. We review arguments that indicate that market discipline is limited by lack of information and may be dangerously distorted by moral hazard induced by official guarantees. Aside from these well-known concerns, we show that the market fails to internalize country risk and panic risk, which leads to inefficient borrowing even in the absence of traditional distortions. We also discuss optimal tax and trade policy as well as the role of liquidity facilities to address these externalities.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 122.

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Date of creation: Nov 2001
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Handle: RePEc:chb:bcchwp:122

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  1. Corsetti, G. & Pesenti, P. & Roubini, N., 1998. "What Caused the Asian Currency and Financial Crisis?," Papers 343, Banca Italia - Servizio di Studi.
  2. Michael P. Dooley, 1998. "A model of crises in emerging markets," International Finance Discussion Papers 630, Board of Governors of the Federal Reserve System (U.S.).
  3. Andrew Atkeson & Jose-Victor Rios-Rull, 1995. "The Balance of Payments and Borrowing Constraints: An Alternative View of the Mexican Crisis," NBER Working Papers 5329, National Bureau of Economic Research, Inc.
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  7. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  8. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
  9. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
  10. Fernandez-Arias, Eduardo & Montiel, Peter J, 1996. "The Surge in Capital Inflows to Developing Countries: An Analytical Overview," World Bank Economic Review, World Bank Group, vol. 10(1), pages 51-77, January.
  11. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  12. McKinnon, Ronald I & Pill, Huw, 1997. "Credible Economic Liberalizations and Overborrowing," American Economic Review, American Economic Association, vol. 87(2), pages 189-93, May.
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