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

  • Guillermo Calvo

    (Columbia University and NBER (E-mail:

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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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
Date of revision:
Handle: RePEc:ime:imedps:13-e-09
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  1. Dvorak, Tomas, 2003. "Gross capital flows and asymmetric information," Journal of International Money and Finance, Elsevier, vol. 22(6), pages 835-864, November.
  2. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  3. Reinhart, Carmen & Reinhart, Vincent, 2010. "Diminished Expectations, Double Dips, and External Shocks: The Decade After the Fall," MPRA Paper 24969, University Library of Munich, Germany.
  4. 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.
  5. 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.
  6. Gary Gorton & Andrew Metrick, 2010. "Securitized Banking and the Run on Repo," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  7. Javier Bianchi, 2009. "Overborrowing and systemic externalities in the business cycle," FRB Atlanta Working Paper 2009-24, Federal Reserve Bank of Atlanta.
  8. Guillermo A. Calvo & Alejandro Izquierdo & Luis Fernando Mejía, 2008. "Systemic Sudden Stops: The Relevance of Balance-Sheet Effects and Financial Integration," Research Department Publications 4581, Inter-American Development Bank, Research Department.
  9. Broner, Fernando & Didier, Tatiana & Erce, Aitor & Schmukler, Sergio L., 2013. "Gross capital flows: Dynamics and crises," Journal of Monetary Economics, Elsevier, vol. 60(1), pages 113-133.
  10. 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, December.
  11. von Hayek, Friedrich August, 1974. "The Pretence of Knowledge," Nobel Prize in Economics documents 1974-2, Nobel Prize Committee.
  12. Dani Rodrik & Andres Velasco, 1999. "Short-Term Capital Flows," NBER Working Papers 7364, National Bureau of Economic Research, Inc.
  13. 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.
  14. Enrique G. Mendoza & Marco E. Terrones, 2008. "An anatomy of credit booms: evidence from macro aggregates and micro data," International Finance Discussion Papers 936, Board of Governors of the Federal Reserve System (U.S.).
  15. Copeland, Adam & Martin, Antoine & Walker, Michael, 2011. "Repo runs: evidence from the tri-party repo market," Staff Reports 506, Federal Reserve Bank of New York, revised 01 Aug 2014.
  16. 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.
  17. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters, in: This Time Is Different: Eight Centuries of Financial Folly Princeton University Press.
  18. Borio, Claudio, 2014. "The financial cycle and macroeconomics: What have we learnt?," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 182-198.
  19. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  20. 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.
  21. 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.
  22. Reinhart, Karmen & Rogoff, Kenneth, 2009. ""This time is different": panorama of eight centuries of financial crises," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 77-114, March.
  23. 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.
  24. 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.
  25. Enrique G. Mendoza, 2010. "Sudden Stops, Financial Crises, and Leverage," American Economic Review, American Economic Association, vol. 100(5), pages 1941-66, December.
  26. Agosin, Manuel R. & Huaita, Franklin, 2012. "Overreaction in capital flows to emerging markets: Booms and sudden stops," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1140-1155.
  27. 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.
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