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Financial crises after financial liberalization: Exceptional circumstances or structural weakness?

  • Weller, Christian E.

Recent studies have conjectured that there may be a link between financial liberalization and financial instability in emerging economies. Most of these studies, however, do not investigate whether emerging economies are becoming structurally more vulnerable to currency and banking crises. In this paper, we argue that emerging economies are systematically becoming more susceptible to both currency and banking crises after FL. Using data for 27 emerging economies from 1973 to the present, univariate and multivariate analyses indicate that the likelihood of currency crises and banking crises increase after FL. In particular, liberalization allows more liquidity to enter an emerging economy, which finds its way into productive and speculative projects. What is common to both types of crises is a significant increase in speculative financing, thereby increasing the chance for borrower default. Thus, the outflow of international capital becomes more likely, and we find that the chance of either type of crisis grows faster in response to changes in short-term loans after FL than before. Similarly, the reactions to overvalued currencies are at least similar in terms of increasing probabilities of crises in the case of banking crises, or greater in the case of currency crises after FL as compared to before FL. Further, our results show that after FL the chance of a currency crisis declines over time, while the chance of a banking crisis increases.

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Paper provided by ZEI - Center for European Integration Studies, University of Bonn in its series ZEI Working Papers with number B 15-1999.

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Date of creation: 1999
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Handle: RePEc:zbw:zeiwps:b151999
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  1. International Monetary Fund, 1998. "The Relative Importance of Political and Economic Variables in Creditworthiness Ratings," IMF Working Papers 98/46, International Monetary Fund.
  2. Bernd Schnatz, 2000. "Speculative attacks in emerging markets: The role of macroeconomic fundamentals," Intereconomics: Review of European Economic Policy, Springer, vol. 35(2), pages 81-89, March.
  3. Barry Eichengreen, Andrew K. Rose, and Charles Wyplosz., 1995. "Is There a Safe Passage to EMU? Evidence on Capital Controls and a Proposal," Center for International and Development Economics Research (CIDER) Working Papers C95-047, University of California at Berkeley.
  4. Nadeem Ul Haque & Manmohan S. Kumar & Nelson Mark & Donald J. Mathieson, 1996. "The Economic Content of Indicators of Developing Country Creditworthiness," IMF Staff Papers, Palgrave Macmillan, vol. 43(4), pages 688-724, December.
  5. Reinhart, Carmen & Calvo, Sara, 1996. "Capital Flows to Latin America: Is There Evidence of Contagion Effects?”," MPRA Paper 7124, University Library of Munich, Germany.
  6. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  7. Graciela Laura Kaminsky, 1997. "Leading Indicators of Currency Crises," IMF Working Papers 97/79, International Monetary Fund.
  8. Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers 534, Board of Governors of the Federal Reserve System (U.S.).
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