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Lax Public Sector, Destabilizing Private Sector: Origins of Capital Market Crises

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Abstract

A principal message of this paper is that external financial crises are not caused by an alert private sector pouncing upon the public sector's foolish actions such as running an unsustainable fiscal deficit or creating moral hazards. They are better described as private sectors (both domestic and foreign) acting to make high short-term profits when policy and history provide the preconditions and the public sector acquiesces. This conclusion emerges from a review of balance of payments crises in the Southern Cone around 1980, Mexico in 1994-95, East Asia in 1997-98, and Russia in 1998 in light of existing theories - speculative attack models and moral hazard - and a synthesis of ideas proposed by Salih Neftci and Roberto Frenkel. The standard theories do not explain history well. The Frenkel-Neftci framework supports a better description of crisis dynamics in terms of five elements:(1) the nominal exchange rate is fixed or close to being pre-determined; (2) there are few barriers to external capital inflows and outflows; (3) historical factors and the conjuncture act together to create wide financial "spreads" between returns to national assets and borrowing rates abroad - these in turn generate capital inflows which push the domestic financial system in the direction of being long on domestic assets and short on foreign holdings; (4) regulation of the system is lax and probably pro-cyclical; (5) stock-flow repercussions of these initially microeconomic changes through the balance of payments and the financial system's flows of funds and balance sheets set off a dynamic macro process which is unstable. Policy alternatives are discussed in terms of these five conditions and the present global macroeconomic environment, in particular the destabilizing interventions of the International Monetary Fund in East Asia.

Suggested Citation

  • Lance Taylor, 1998. "Lax Public Sector, Destabilizing Private Sector: Origins of Capital Market Crises," SCEPA working paper series. 1998-11, Schwartz Center for Economic Policy Analysis (SCEPA), The New School, revised Oct 1998.
    • Handle: RePEc:epa:cepawp:1998-11
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    1. Yeldan Erinc A., 2008. "Prospects for Inflation Targeting in the MENA Region: Feasibility, Desirability and Alternatives," Review of Middle East Economics and Finance, De Gruyter, vol. 4(3), pages 83-100, September.
    2. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June.
    3. Ozlem Onaran, 2004. "Life After Crisis For Labor And Capital in the Era of Neoliberal Globalization," Working Papers geewp43, Vienna University of Economics and Business Research Group: Growth and Employment in Europe: Sustainability and Competitiveness.
    4. Juan Antonio Montecino & Jose Antonio Cordero, 2010. "Capital Controls and Monetary Policy in Developing Countries," CEPR Reports and Issue Briefs 2010-10, Center for Economic and Policy Research (CEPR).
    5. Nicholas Snowden, 1999. "The international financial architecture after the Asian crisis: learning from Las Vegas?," Journal of International Development, John Wiley & Sons, Ltd., vol. 11(1), pages 107-119.
    6. TUNCEL, Cem Okan, 2012. "Finansal Liberalizasyon ve Küresel Krizin Yapısal Nedenleri: Gelişmekte Olan Ülkeler İçin Dersler [Financial Liberalization and the Structural Roots of the Global Crises: Lessons for Developing Cou," MPRA Paper 42422, University Library of Munich, Germany.
    7. Rapetti, Martin, 2005. "The Argentine Macroeconomy during the Post-Convertibility Period: Performance, Debates and Perspectives," MPRA Paper 57901, University Library of Munich, Germany.
    8. Demir, Firat, 2004. "A Failure Story: Politics and Financial Liberalization in Turkey, Revisiting the Revolving Door Hypothesis," World Development, Elsevier, vol. 32(5), pages 851-869, May.
    9. Carlos E. Schonerwald da Silva & Matías Vernengo, 2007. "Foreign Exchange, Interest and the Dynamics of Public Debt in Latin America," Working Paper Series, Department of Economics, University of Utah 2007_02, University of Utah, Department of Economics.
    10. Mario Damill, 2005. "The Argentinean Debt: History, Default and Restructuring," Economia, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics], vol. 6(3), pages 29-90.
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    12. Aşıcı, Ahmet Atıl, 2015. "On the sustainability of the economic growth path of Turkey: 1995–2009," Renewable and Sustainable Energy Reviews, Elsevier, vol. 52(C), pages 1731-1741.
    13. Damill, Mario. & Frenkel, Roberto. & Maurizio, Roxana., 2011. "Macroeconomic policy for full and productive employment and decent work for all an analysis of the Argentine experience," ILO Working Papers 994677873402676, International Labour Organization.
    14. Erinc Yeldan, 2009. "On the Nature and Causes of the Collapse of the Wealth of Nations, 2007-2008: The End of a Façade Called Globalization," Working Papers wp197, Political Economy Research Institute, University of Massachusetts at Amherst.
    15. Damill, Mario & Frenkel, Roberto, 2006. "The Argentine labour market in a financially globalized world," Revista CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), April.
    16. Adelman, Irma & Yeldan, Erinc, 2000. "The Minimal Conditions for a Financial Crisis: A Multiregional Intertemporal CGE Model of the Asian Crisis," World Development, Elsevier, vol. 28(6), pages 1087-1100, June.
    17. Nderitu Kingori, 2016. "Market Structure, Macroeconomic Shocks, and Banking Risk in Kenya," Econometric Research in Finance, SGH Warsaw School of Economics, Collegium of Economic Analysis, vol. 1(2), pages 81-113, December.
    18. Mathew Bradbury & Matías Vernengo, 2008. "The Limits to Dollarization in Ecuador: Lessons from Argentina," Working Paper Series, Department of Economics, University of Utah 2008_12, University of Utah, Department of Economics.

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