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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.
Contact details of provider: Web page: http://128.118.178.162

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  1. John B. Shoven & Scott B. Smart & Joel Waldfogel, 1992. "Real Interest Rates and the Savings and Loan Crisis: The Moral Hazard Premium," Journal of Economic Perspectives, American Economic Association, vol. 6(1), pages 155-167, Winter.
  2. Paul R. Masson, 1998. "Contagion; Monsoonal Effects, Spillovers, and Jumps Between Multiple Equilibria," IMF Working Papers 98/142, International Monetary Fund.
  3. Graciela Laura Kaminsky, 1999. "Currency and Banking Crises; The Early Warnings of Distress," IMF Working Papers 99/178, International Monetary Fund.
  4. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  5. Graciela Laura Kaminsky, 1997. "Leading Indicators of Currency Crises," IMF Working Papers 97/79, International Monetary Fund.
  6. Chang, R. & Velasco, A., 1998. "Financial Fragility and the Exchange Rate Regime," Working Papers 98-05, C.V. Starr Center for Applied Economics, New York University.
  7. Pierre-Richard Agenor & Joshua Aizenman, 1998. "Volatility and the Welfare Costs of Financial Market Integration," NBER Working Papers 6782, National Bureau of Economic Research, Inc.
  8. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "What caused the Asian currency and financial crisis?," Japan and the World Economy, Elsevier, vol. 11(3), pages 305-373, October.
  9. Obstfeld, Maurice, 1996. "Models of Currency Crises with Self-fulfilling Features," CEPR Discussion Papers 1315, C.E.P.R. Discussion Papers.
  10. Ilan Goldfajn & Rodrigo O. Valdés, 1997. "Capital Flows and the Twin Crises ; The Role of Liquidity," IMF Working Papers 97/87, International Monetary Fund.
  11. Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, vol. 110(460), pages 236-55, January.
  12. Razin, Assaf & Sadka, Efraim & Yuen, Chi-Wa, 1996. "A Pecking Order Theory of Capital Inflows and International Tax Principles," CEPR Discussion Papers 1381, C.E.P.R. Discussion Papers.
  13. 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.
  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. Frederic S. Mishkin, 1991. "Anatomy of a Financial Crisis," NBER Working Papers 3934, National Bureau of Economic Research, Inc.
  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. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
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