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Puzzling over the Anatomy of Crises: Liquidity and the Veil of Finance

  • Guillermo Calvo

    (Columbia University and NBER (E-mail: gc2286@columbia.edu))

The paper claims that conventional monetary theory obliterates the central role played by media of exchange in the workings and instability of capitalist economies; and that a significant part of the financial system depends on the resiliency of paper currency and liquid assets that have been built on top of it. The resilience of the resulting financial tree is questionable if regulators are not there to adequately trim its branches to keep it from toppling by its own weight or minor wind gusts. The issues raised in the paper are not entirely new but have been ignored in conventional theory. This is very strange because disregard for these key issues has lasted for more than half a century. Are we destined to keep on making the same mistake? The paper argues that a way to prevent that is to understand its roots, and traces them to the Keynes/Hicks tradition. In addition, the paper presents a narrative and some empirical evidence suggesting a key channel from Liquidity Crunch to Sudden Stop, which supports the view that liquidity/credit shocks have been a central factor in recent crises. In addition, the paper claims that liquidity considerations help to explain (a) why a credit boom may precede financial crisis, (b) why capital inflows grow in the run-up of balance-of-payments crises, and (c) why gross flows are pro-cyclical.

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File URL: http://www.imes.boj.or.jp/research/papers/english/13-E-09.pdf
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Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 13-E-09.

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Date of creation: Sep 2013
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Handle: RePEc:ime:imedps:13-e-09
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  1. Carmen M. Reinhart & Vincent Reinhart, 2010. "After the fall," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 17-60.
  2. Broner, Fernando & Didier, Tatiana & Erce, Aitor & Schmukler, Sergio L., 2011. "Gross capital flows : dynamics and crises," Policy Research Working Paper Series 5768, The World Bank.
  3. Calvo, Guillermo & Coricelli, Fabrizio & Ottonello, Pablo, 2012. "The Labor Market Consequences of Financial Crises With or Without Inflation: Jobless and Wageless Recoveries," CEPR Discussion Papers 9218, C.E.P.R. Discussion Papers.
  4. Javier Bianchi, 2010. "Overborrowing and Systemic Externalities in the Business Cycle," 2010 Meeting Papers 96, Society for Economic Dynamics.
  5. Borio, Claudio, 2014. "The financial cycle and macroeconomics: What have we learnt?," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 182-198.
  6. Guillermo A. Calvo, 2012. "The Price Theory of Money, Prospero's Liquidity Trap, and Sudden Stop: Back to Basics and Back," NBER Working Papers 18285, National Bureau of Economic Research, Inc.
  7. Michael D. Bordo, 2006. "Sudden Stops, Financial Crises, and Original Sin in Emerging Countries: Déjà vu?," NBER Working Papers 12393, National Bureau of Economic Research, Inc.
  8. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  9. Guillermo A. Calvo & Alejandro Izquierdo & Luis Fernando Mejía, 2008. "Systemic Sudden Stops: The Relevance of Balance-Sheet Effects and Financial Integration," IDB Publications (Working Papers) 6747, Inter-American Development Bank.
  10. Dvorak, Tomas, 2003. "Gross capital flows and asymmetric information," Journal of International Money and Finance, Elsevier, vol. 22(6), pages 835-864, November.
  11. Guillermo A. Calvo & Alejandro Izquierdo & Ernesto Talvi, 2006. "Phoenix Miracles in Emerging Markets: Recovering without Credit from Systemic Financial Crises," Research Department Publications 4474, Inter-American Development Bank, Research Department.
  12. Gary Gorton & Andrew Metrick, 2009. "Securitized Banking and the Run on Repo," Yale School of Management Working Papers amz2358, Yale School of Management, revised 01 Sep 2009.
  13. Dani Rodrik & Andres Velasco, 1999. "Short-Term Capital Flows," NBER Working Papers 7364, National Bureau of Economic Research, Inc.
  14. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  15. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1993. "“Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," MPRA Paper 7125, University Library of Munich, Germany.
  16. Guillermo Calvo & Alejandro Izquierdo & Rudy Loo-Kung, 2013. "Optimal Holdings of International Reserves: Self-insurance against Sudden Stops," Monetaria, Centro de Estudios Monetarios Latinoamericanos, vol. 0(1), pages 1-35, January-j.
  17. Adam Copeland & Antoine Martin & Michael Walker, 2014. "Repo Runs: Evidence from the Tri-Party Repo Market," Journal of Finance, American Finance Association, vol. 69(6), pages 2343-2380, December.
  18. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates
    [This Time Is Different: Eight Centuries of Financial Folly]
    ," Introductory Chapters, Princeton University Press.
  19. Enrique G. Mendoza, 2010. "Sudden Stops, Financial Crises, and Leverage," American Economic Review, American Economic Association, vol. 100(5), pages 1941-66, December.
  20. Enrique G. Mendoza & Marco E. Terrones, 2008. "An Anatomy Of Credit Booms: Evidence From Macro Aggregates And Micro Data," NBER Working Papers 14049, National Bureau of Economic Research, Inc.
  21. Manuel Agosin & Franklin Huaita, 2009. "Overreaction in capital flows to emerging markets: Booms and sudden stops," Working Papers wp295, University of Chile, Department of Economics.
  22. von Hayek, Friedrich August, 1989. "The Pretence of Knowledge," American Economic Review, American Economic Association, vol. 79(6), pages 3-7, December.
  23. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  24. Guillermo A. Calvo, 2005. "Emerging Capital Markets in Turmoil: Bad Luck or Bad Policy?," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262033348, June.
  25. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 35-54, November.
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