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The Asian liquidity crisis

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Roberto Chang
Andres Velasco

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Abstract

A country's financial system is internationally illiquid if its potential short-term obligations in foreign currency exceed the amount of foreign currency it can have access to in short notice. This condition may be necessary and sufficient for financial crises and/or exchange rate collapses (Chang and Velasco 1998a, b). In this paper we argue that the 1997-98 crises in Asia were in fact a consequence of international illiquidity. This follows from an analysis of empirical indicators of illiquidity as well as other macroeconomic statistics. We trace the emergence of illiquidity to financial liberalization, the shortening of the foreign debt structure, and the currency denomination of assets versus liabilities. We explain how financial crises became exchange rate collapses due to a government policy of both fixing exchange rates and acting as lender of last resort. Finally, we outline the policy implications of our view for preventing crises and for dealing with them.

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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 98-11.

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Date of creation: 1998
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Handle: RePEc:fip:fedawp:98-11

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Keywords: Banks and banking; Central ; International finance ; Liquidity (Economics) ; Monetary policy ; Money supply;

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  1. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," Working Paper 98-10, Federal Reserve Bank of Atlanta. [Downloadable!]
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  2. Diaz-Alejandro, Carlos, 1985. "Good-bye financial repression, hello financial crash," Journal of Development Economics, Elsevier, vol. 19(1-2), pages 1-24. [Downloadable!] (restricted)
  3. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  4. Diamond, Douglas W, 1997. "Liquidity, Banks, and Markets," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 928-56, October.
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  5. Corsetti, G. & Pesenti, P. & Roubini, N., 1998. "What Caused the Asian Currency and Financial Crisis?," Papers 343, Banca Italia - Servizio di Studi.
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  6. Michael Gavin & Ricardo Hausmann, 1996. "The Roots of Banking Crises: The Macroeconomic Context," RES Working Papers 4026, Inter-American Development Bank, Research Department. [Downloadable!]
  7. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Jeffrey Sachs & Aaron Tornell & Andres Velasco, 1996. "The Mexican Peso Crisis: Sudden Death or Death Foretold?," NBER Working Papers 5563, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. 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. [Downloadable!] (restricted)
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  10. Ilan Goldfajn & Rodrigo O. Valdés, 1997. "Capital Flows and the Twin Crises : The Role of Liquidity," IMF Working Papers 97/87, International Monetary Fund.
  11. 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(1993-2), pages 1-74. [Downloadable!]
  12. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. 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.). [Downloadable!]
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  14. 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. [Downloadable!] (restricted)
  15. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. 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(1995-2), pages 219-294. [Downloadable!]
  17. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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