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Market Discipline and Exuberant Foreign Borrowing

In: Banking, Financial Integration, and International Crises

  • Eduardo Fernández-Arias

    (Inter-American Development Bank)

  • Davide Lombardo

    (Stanford University)

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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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 11, pages 333-360, 2002.
This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v03c11pp333-360.
Handle: RePEc:chb:bcchsb:v03c11pp333-360
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  1. McKinnon, Ronald I & Pill, Huw, 1997. "Credible Economic Liberalizations and Overborrowing," American Economic Review, American Economic Association, vol. 87(2), pages 189-93, May.
  2. Enrica Detragiache, 1996. "Rational Liquidity Crises in the Sovereign Debt Market; In Search of a Theory," IMF Working Papers 96/38, International Monetary Fund.
  3. Andrew Atkeson & Jose-Victor Rios-Rull, 1996. "The balance of payments and borrowing constraints: an alternative view of the Mexican crisis," Staff Report 212, Federal Reserve Bank of Minneapolis.
  4. 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.
  5. 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.
  6. Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
  7. Michael P. Dooley, 1997. "A Model of Crises in Emerging Markets," NBER Working Papers 6300, National Bureau of Economic Research, Inc.
  8. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
  9. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  10. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, June.
  11. Harberger, Arnold C, 1980. "Vignettes on the World Capital Market," American Economic Review, American Economic Association, vol. 70(2), pages 331-37, May.
  12. 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.
  13. Carlos F. Diaz-Alejandro, 1984. "Latin American Debt: I Don't Think We Are in Kansas Anymore," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 335-403.
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