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Financial Crises in Emerging Markets: The Lessons from 1995

  • Jeffrey Sachs
  • Aaron Tornell
  • Andres Velasco

In this paper we examine closely the financial events following the Mexican peso devaluation to uncover new lessons about the nature of financial crises. We explore the question of why, during 1995, some emerging markets were hit by financial crises while others were not. To this end, we ask whether there are some fundamentals that help explain the variation in financial crises across countries or whether the variation just reflects contagion. We present a simple model identifying three factors that determine whether a country is more vulnerable to suffer a financial crisis: a high real exchange rate appreciation, a recent lending boom, and low reserves. We find that for a set of 20 emerging markets, differences in these fundamentals go far in explaining why during 1995 some emerging markets were hit by financial crises while others were not. We also find that alternative hypotheses that have been put forth to explain such crises often do not seem to be supported by the data, such as high current account deficits, excessive capital inflows and loose fiscal policies.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5576.

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Date of creation: May 1996
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Publication status: published as Brookings Papers on Economic Activity, 1996, No. 1 (vol. 27): 147-199
Handle: RePEc:nbr:nberwo:5576
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