Editors' Summary

The brookings panel on Economic Activity held its seventy-first conference in Washington, D.C., on March 29 and 30, 2001. This issue of Brookings Papers on Economic Activity includes the papers and discussions presented at the conference. The first paper investigates the causes of the Russian financial crisis of 1998 and evaluates the emergency international effort that was undertaken to avert the crisis. The second paper studies the effect of interstate wage differences on the location decisions of immigrants and estimates the resulting gains in macroeconomic efficiency. The first report analyzes whether the decreased frequency of recessions in the past two decades can be attributed to a secular decline in the variability of quarter-to-quarter changes in output. The second report examines the usefulness of the Index of Consumer Sentiment as a tool for forecasting recessions. The issue concludes with a symposium of three papers on the sustainability of the recent large current account deficits in the U.S. balance of payments. Each takes a somewhat different approach to understanding these deficits. The first symposium paper sees U.S. assets as attractive investments that are likely to perpetuate large capital account surpluses. The second focuses on entrenched global demand for the dollar as international money. The third paper views capital flows in terms of a country portfolio model in which investors at home and abroad increase or reduce their holdings of U.S. assets in response to changes in wealth and in risk-adjusted returns.

In the summer of 1998 the flight of capital from Russia in the face of failed attempts by the International Monetary Fund (IMF) and others to stabilize the ruble caused a crisis that reverberated throughout the world's financial markets. The IMF had sought to avoid the inflation and financial market disruption that a sharp devaluation might bring and to encourage and facilitate fiscal and structural reforms within Russia. When the effort failed, inflation soared, output declined, and the reformist government of Prime Minister Sergei Kirienko fell. The Russian meltdown was followed by sharp declines in stock markets worldwide; it also led to massive losses at Long Term Capital Management, a large U.S.-based hedge fund, whose potential failure U.S. authorities and other knowledgeable observers saw as a threat to the financial system. In the first paper of this issue, Homi Kharas, Brian Pinto, and Sergei Ulatov analyze the Russian crisis and the response of the international community.

The authors first review the economic situation in Russia in the years leading up to the crisis. The policy of stabilizing the exchange rate around a crawling peg had helped bring annual inflation down from 200 percent in 1994 to near 10 percent in 1997. But otherwise performance had been dismal. National output, which had fallen by 40 percent between 1990 and 1995, continued to stagnate or decline over the next two years. And Russia's financial situation worsened after the East Asian crisis started in the summer of 1997. In the first half of that year, foreign investment in Russian equities and government short-term debt had risen sharply, raising the foreign reserves of the Central Bank of Russia (CBR) to $25 billion by July. But by the fall, some of the capital inflows had reversed and interest rates on GKOs (short-term government debt instruments) were rising. Under pressure from the IMF, the government formulated a new Fiscal Action Plan designed to increase tax collection and control expenditure. In subsequent months such commitments to reform would be repeated in the face of growing skepticism about the government's ability to deliver on them. And by the late spring of 1998, in an environment of rising interest rates and falling oil prices, the third and final bout of instability began, coincident with the crisis in Indonesia.

The international financial community reacted forcefully. In June 1998 the IMF released a $670 million tranche of a previously negotiated loan, and in July an IMF-led rescue package totaling $22.6 billion was announced, with funds committed mainly from the IMF and the World Bank but including $1.5 billion from the government...