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Financial Crisis and Credit Crunch as a Result of Inefficient Financial Intermediation—with Reference to the Asian Financial Crisis

  • Jorge A. Chan-Lau

    (International Monetary Fund)

  • Zhaohui Chen

    (International Monetary Fund and CEPR)

This paper develops a new model of international private debt financing. It shows the possibility of discontinuity in the amount of financial intermediation when the intermediary is inefficient. The model suggests a mechanism that can generate the following sequence of events: A period of relatively low capital flow despite a steady improvement in economic fundamentals (capital inflow inertia), followed by a fast buildup of capital inflow, and ended with a large capital outflow (crisis), as observed in the recent Asian financial crisis. In addition, there exists a minimum level of economic fundamental strength that can sustain large capital inflows. If the fundamental strength is not far above this minimum level, the economy will be vulnerable to shifts in market sentiment and to even a small deterioration of fundamentals. We use comparative statics to evaluate the pros and cons of various policy responses to the crisis.

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Paper provided by EconWPA in its series International Finance with number 9804001.

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Length: 23 pages
Date of creation: 21 Apr 1998
Date of revision: 24 Apr 1998
Handle: RePEc:wpa:wuwpif:9804001
Note: Type of Document - Postscript/Acrobat PDF; prepared on IBM PC using MiKTeX 1.10; to print on HP Laser Jet; pages: 23 ; figures:2 included. Postscript version prepared using dvips5.76, pdf version prepared from postscript version with ps2pdf.
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  1. Chi-Wa Yuen & Assaf Razin & Efraim Sadka, 1996. "A Pecking Order Theory of Capital Inflows and International Tax Principles," IMF Working Papers 96/26, International Monetary Fund.
  2. John B. Shoven & Scott B. Smart & Joel Waldfogel, 1991. "Real Interest Rates and the Savings and Loan Crisis: The Moral Hazard Premium," NBER Working Papers 3754, National Bureau of Economic Research, Inc.
  3. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," FRB Atlanta Working Paper No. 97-16, Federal Reserve Bank of Atlanta.
  4. Agenor, Pierre-Richard & Aizenman, Joshua, 1998. "Volatility and the welfare costs of financial market integration," Policy Research Working Paper Series 1974, The World Bank.
  5. 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.
  6. Mishkin, Frederic S, 1992. "Anatomy of a Financial Crisis," Journal of Evolutionary Economics, Springer, vol. 2(2), pages 115-30, August.
  7. Obstfeld, Maurice, 1996. "Models of Currency Crises with Self-fulfilling Features," CEPR Discussion Papers 1315, C.E.P.R. Discussion Papers.
  8. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "What Caused the Asian Currency and Financial Crisis?," Temi di discussione (Economic working papers) 343, Bank of Italy, Economic Research and International Relations Area.
  9. Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, vol. 110(460), pages 236-55, January.
  10. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  11. Graciela Laura Kaminsky, 1997. "Leading Indicators of Currency Crises," IMF Working Papers 97/79, International Monetary Fund.
  12. Graciela L. Kaminsky, 1998. "Currency and banking crises: the early warnings of distress," International Finance Discussion Papers 629, Board of Governors of the Federal Reserve System (U.S.).
  13. Ilan Goldfajn & Rodrigo O. Valdés, 1997. "Capital Flows and the Twin Crises ; The Role of Liquidity," IMF Working Papers 97/87, International Monetary Fund.
  14. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  15. Paul R. Masson, 1998. "Contagion; Monsoonal Effects, Spillovers, and Jumps Between Multiple Equilibria," IMF Working Papers 98/142, International Monetary Fund.
  16. Zhaohui Chen & Mohsin S. Khan, 1997. "Patterns of Capital Flows to Emerging Markets; A Theoretical Perspective," IMF Working Papers 97/13, International Monetary Fund.
  17. By Jorge A. Chan-Lau & Zhaohui Chen, 2001. "Crash-Free Sequencing Strategies for Financial Development and Liberalization," IMF Staff Papers, Palgrave Macmillan, vol. 48(1), pages 7.
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