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Paper tigers? A model of the Asian crisis

  • Giancarlo Corsetti
  • Paolo Pesenti
  • Nouriel Roubini

This paper develops an interpretation of the Asian meltdown focused on moral hazard as the common source of overinvestment, excessive external borrowing, and current account deficits. To the extent that foreign creditors are willing to lend to domestic agents against future bail-out revenue from the government, unprofitable projects and cash shortfalls are refinanced through external borrowing. While public deficits need not be high before a crisis, the eventual refusal of foreign creditors to refinance the country's cumulative losses forces the government to step in and guarantee the outstanding stock of external liabilities. To satisfy solvency, the government must then undertake appropriate domestic fiscal reforms, possibly involving recourse to seigniorage revenues. Expectations of inflationary financing thus cause a collapse of the currency and anticipate the event of a financial crisis. The empirical section of the paper presents evidence in support of the thesis that weak cyclical performances, low foreign exchange reserves, and financial deficiencies resulting in high shares of nonperforming loans were at the core of the Asian collapse.

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Paper provided by Federal Reserve Bank of New York in its series Research Paper with number 9822.

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Date of creation: 1998
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Handle: RePEc:fip:fednrp:9822
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