Brookings Trade Forum 2002 (2002) ix-xviii
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Susan M. Collins
Currency crises are paramount but extremely perplexing problems in today's international economy. Initially erupting in a country's financial markets, these crises typically spread throughout a country'seconomy and beyond—often with devastating consequences for real economic activity. The resultant reductions in domestic living standards can be severe and long lasting. Why do such crises continue to erupt? Can the growing number of past experiences enable us to better understand current crises, mitigate their impact, and prevent additional crises from occurring in the future?
Brookings Trade Forum 2002 brought together experts on the two most recent crises—in Argentina and Turkey—as well as economists and policymakers who have studied currency crises more broadly. The result was a lively and informed debate, conducted in three sessions. One session focused on the ongoing crisis in Argentina. The two papers presented in this session provide quite different assessments of what went wrong and what might have been done differently to prevent the crisis. A second session focused on the recent experience in Turkey. The third session, a discussion launched by three panelists, provided an open-ended discussion of the lessons to be drawn for the future.
The fifth annual conference of the Brookings Trade Forum was held in Washington on May 2, 2002. This volume contains the papers, panelist remarks, invited commentary, and general discussions from that conference.
In the first paper, Andrew Powell argues that the Argentine crisis was not inevitable and could have been avoided. While the currency was overvalued by conventional measures, especially after the devaluation of the Brazilian real, he finds that Argentina's current account had more or less adjusted by the end of 2000. And while Argentina did need a fiscal adjustment, he argues that until the end of 2000, and perhaps even until the second quarter of 2001, [End Page ix] the magnitude of the required adjustment was relatively small. In actuality Argentina accomplished virtually no fiscal adjustment whatsoever.
Powell argues that the root of Argentina's crisis was, therefore, the interaction of four factors. First, the country suffered from bad luck, including a significant decline in its terms of trade and a recession in Brazil, its main trading partner. Second, fiscal adjustment, though moderate, was required. Third, the current account adjustment process was very slow, involving both deflation and recession. Finally, and very important, Argentina's politics were extremely messy—hence its inability to reduce national spending without creating enormous political uncertainty. Powell presents the interaction of these factors as a vicious, self-enforcing cycle, potentially implying multiple equilibria, both for the economic variables and between the economic and political outcomes.
Powell's paper opens with a brief description of the events beginning in the late 1990s. The paper then uses vector autoregression (VAR) analysis to study the linkages between these variables. Powell finds significant interrelations between key economic and political indicators. In particular, political risk fed through to worsened economic fundamentals, and these fed back to increased political risk. Low fiscal revenues and lower imports fed through to higher spreads on Argentina's international bonds, which in turn fed back to both lower imports and budgetary difficulties instead of fiscal revenues. The results support the view that politics and fiscal variables were key drivers of Argentina's problems.
Different authors have criticized the role of the International Monetary Fund (IMF) in Argentina. Powell argues that the International Monetary Fund was in an impossible position. Although the IMF became increasingly uncomfortable with Argentina's policies, it also recognized that withdrawal of its support would likely create the conditions for a private sector run that would end in default and probable devaluation. The IMF was thus caught between its growing concern about moral hazard and the possibility of a run. Powell argues that this dilemma is likely to characterize future IMF relations with countries in a crisis.
The lack of support for the March 2001 Lopez-Murphy plan marked a watershed, which can be seen as identifying the limits of the adjustment in government spending that was politically feasible under...