Financial Crises: Lessons from the Past, Preparation for the Future

Chapter 1. Introduction

 Introduction 1 The calm before the storm? That question dominated the stage at the seventh annual conference on emerging markets finance, cosponsored by the World Bank and the Brookings Institution and held at Brookings in late April 2005. At the time of the conference, it had been a little less than eight years since the onset of the Asian financial crisis, an event that had depression-like effects throughout much of Asia and, for a time, seemed to threaten global economic stability. That this outcome never happened can be attributed to a combination of aggressive monetary easing by the Federal Reserve Board in the United States, emergency lending to the countries in the region by the International Monetary Fund (IMF) and other international institutions, the concerted rollover of some of Korea’s private external debt, and a dose of good luck. The Asian economies have since recovered from their financial crises to varying degrees, as have the other major emerging-market countries that suffered their own crises shortly afterward: Argentina, Brazil, Russia, and Turkey. What has been learned since these crises in key parts of the developing world? How exposed are countries in different parts of the world to another, perhaps entirely different kind of financial and economic crisis? These are among the questions that the conference papers address. This introduction provides a brief overview of their main findings. The subsequent chapters contain the papers as well as a summary of the panel discussion with gerard caprio james hanson robert e. litan private sector representatives of commercial banks and rating agencies and select portions of the discussion by the roughly 100 financial experts from around the world who attended the conference. James Hanson led off the conference by examining the challenges and economic vulnerabilities in East Asia and Latin America. Countries in both regions suffered financial crises in the 1990s and the early part of this decade. In chapter 2, Hanson discusses the common features of the crises in both regions and the very different paths that countries in each region have taken since their crises. Almost all of the crises in the 1990s and post-2000 in both regions were not just external crises; they often began in the domestic banking sectors, and banking sector problems complicated policymaking in all cases. In the typical case, runs on banks quickly turned into runs on currencies, forcing central banks to abandon attempts to peg the exchange rate and deal with bank failures. In some, but not all, cases, excessive government borrowing contributed to the crises, unlike the 1980s-era Latin American crises, where excessive government borrowing was the dominant cause. There also were common elements among the policy responses to the more recent financial crises. Governments typically bailed out bank depositors . They incurred massive debts to the banking systems in the process, since governments also had to pick up the tab for losses on unpaid bank loans that typically were transferred to separate asset management companies. On the macroeconomic front, pressure from the market and the IMF, which provided emergency finance to many of the countries in both regions, sooner or later forced the governments to tighten monetary and fiscal policy. Hanson does not add to the well-known and vigorous debate over these policy responses; instead he focuses factually on what happened in the economies as a result. One of the postcrisis macroeconomic outcomes, common to both regions, was a dramatic drop in inflation, an unusual experience for Latin America, where much higher inflation rates had been common. Lower inflation rates helped the working of the financial system after the crises in all the countries. In terms of growth, the postcrisis experiences have differed between (and within) regions. The East Asian countries generally have rebounded from their crisis-induced downturns. Annual growth recently has been in the 4–6 percent range, good for developing countries, but below their growth rates in the first half of the 1990s. Korea recovered the most rapidly, using the unorthodox strategy of promoting consumption, but its growth then slowed as the approach reached its limits. Indonesia suffered the most from  , ,   its crisis, in part because of the political turmoil surrounding the end of the Suharto regime and realignment of the political economy as the country developed a democratic government. The Latin American countries that suffered crises in the 1990s recovered quickly. Nonetheless, despite their upswing in 2004, their average growth...