Failure of the Fund

The Interest Rate Parity Theorem: A Reinterpretation

For a while, in the darkest moments of the Asian financial crisis in 1998, it was widely predicted that East Asia would continue to be deathly sick for the next two to four years. While it is fortunate that the news of the (near) death of the East Asian miracle was greatly exaggerated, this economic earthquake remains a tragic disaster in human terms. The tremendous destruction of wealth and the pushing of a significant proportion of the population in the poorer countries to below the poverty line caused political volcanoes to erupt in several countries. New governments have emerged in Indonesia, South Korea and Thailand; and the political leadership is split in Malaysia. The social after-shocks of this economic earthquake are still being felt in April 2000. Economist, Dr Manuel Montes (then Senior Fellow at ISEAS) led the academic world with the publication of The Currency Crisis in Southeast Asia in October 1997. This book has become a classic because its penetrating analysis about the causes of the crisis and the prescient predictions of its consequences have stood the test of time.(1) The abrupt ending of the crisis in the first quarter of 1999 prompted Dr Manuel Montes (who had returned to the East-West Center) to organize a workshop in Honolulu, Hawaii, from 30 September to 1 October 1999 to take a fresh look at the crisis. The workshop papers sparked much lively discussion, and pointed to novel directions for research on financial crises in general and reform of the international financial architecture in particular. A subset of these papers is published in this special issue of ASEAN Economic Bulletin. The Crisis in Hindsight For the economics profession, the Asian financial crisis has been divisive and, for some economists, humbling. The International Monetary Fund (IMF), the financial firefighter of the world, under-predicted the severity of the output collapse in every one of its programme countries,(2) and then went on to under-predict the pace and strength of the economic recovery.(3) This systematic failure in prediction by the IMF of output behaviour in the crisis countries certainly suggests an institution that neither understood the cause of the region-wide crisis nor knew what the optimal rescue package for these countries should have been. It was in support of this impression of an incompetent IMF that Joseph Stiglitz, the Chief Economist at the World Bank during the crisis, wrote in April 2000: IMF experts believe that they are brighter, more educated, and less politically motivated than the economists in the countries they visit. In fact.... the IMF staff ... frequently consists of third-rank students from first-rate universities ... Quite frankly, a student who turned in the IMF's answer to the test questions What should be the fiscal stance of Thailand, facing an economic downturn? would have gotten an F.(4) The economics profession is certainly divided over the IMF's performance but not in a clear-cut fashion. For example, as will be clear from the papers in this volume that, although most of the authors agree with Stiglitz that the first IMF programmes for Indonesia, South Korea and Thailand were badly flawed, they differ with regard to his reasons for the IMF mistakes and his negative assessment about the analytical capability of the IMF. The economics profession has shown uncharacteristic humility over its initial judgement of the Asian financial crisis. The well-known economist, Paul Krugman, has conveniently posted on his website a well-documented record of his stream of consciousness about the crisis, so we may use his intellectual odyssey to capture an important evolution of the views of the economics profession towards the Asian financial crisis. In March 1998, Paul Krugman opined that: Broadly speaking, I would say that there are two approaches to the Asian crisis. …

References and Further Reading

THE GLOBAL ECONOMIC MULTILATERALS (GEMs)--the International Monetary Fund (IMF), World Bank, and World Trade Organization (WTO)--occupy a central role in the architecture of global governance. (1) These peak organizations in the domains of monetary and financial relations, development, and trade have owed their position to their efficacy, legitimacy, normative identity, and adaptability. * The GEMs have demonstrated efficacy: they produce discernable results through their actions. They have evolved over time to serve as useful instruments of collaboration among the principal economic powers and, in the eyes of weaker powers, modest constraints on unilateral action by the strong. * Their multilateral character and near-universal membership award them substantial legitimacy. Membership in the IMF and the World Bank (the latter dependent on the former) is nearly automatic for new states. Among members of the United Nations, only two Cold War artifacts (North Korea and Cuba) and a handful of microstates are not members of the international financial institutions (IFIs). Accession to the WTO is more arduous, and a number of Middle Eastern, Central Asian, and African states are not members of the WTO. * The norms and practices of these organizations award them a distinct and controversial identity. The Bretton Woods settlement after 1945 did not embody a hard-edged commitment to liberalized international exchange or unregulated markets. Capital controls were endorsed; a prominent state role in development was accepted; and trade negotiations took place on the basis of reciprocal concession, not unilateral liberalization. By the 1980s, however, the GEMs had become identified with limits on state intervention in the economy and openness to cross-border exchange, the so-called Washington Consensus. (2) The IFIs and the WTO occupied prominent roles as globalizers. (3) * Adaptability has been a final characteristic of the GEMs. They have demonstrated their ability to change in response to new international actors and shifts in the global environment. Under conflicting demands for change today, continued reinvention will be essential. If not, their useful life span may prove to be eight decades. The efficacy of the GEMs was owed to the ability of an expanding club of industrialized countries (with the United States first among equals) to dominate decisionmaking in these organizations. Their usefulness to the club of economic powers became more apparent as trade and financial flows increased in the 1960s. The dominance of these economic powers was based on formal decision rules, such as weighted voting in the IFIs, and informal groups, such as the Quad of trading powers that led negotiations in the General Agreement on Tariffs and Trade (GATT). US influence was amplified beyond its formal vote share by informal governance within the IMF and other organizations. (4) Dominance was also ensured by the relatively weak engagement with the GEMs of most developing countries during this era of import substitution and state-led industrialization. Special and differential treatment was two-edged: developing countries were not held to the same policy standards as industrialized members, but their voice was heavily discounted as a result. This cozy world of club governance came under strain beginning in the 1980s. As large developing economies opened to the international economy, they became more vulnerable to internationally generated shocks (and crises) and more dependent on international trade and finance for economic success. The GEMs promoted this new orientation toward economic openness, but the global multilaterals also became targets of the proponents of national autonomy and the opponents of globalization. Financial crisis management by the IMF (with the World Bank in a supporting role) provoked waves of criticism of the IFIs and their policy prescriptions. The Asian financial crisis in the late 1990s led to disengagement from the IMF, reliance on self-insurance through an accumulation of reserves, and experimentation with regional financial alternatives. …

Turkey's deep financial crisis in 2000-2001 implicated the International Monetary Fund program, adopted in 1999, while the IMF was associated with the successful 2001 recovery program. This article, through studying three critical interventions, finds that the IMF's impact on the policy choices available to Turkey's policymakers varied according to the history of the IMF's engagement with Turkey, the interests of major shareholders in the IMF, and the credibility of Turkey's leaders in the eyes of the IMF. The IMF's engagement substantially affected domestic politics in Turkey by strengthening the voice of economic technocrats within the government. The IMF thus became a contested actor in domestic politics. The crisis had very significant negative economic and social effects, which contributed to a deep political change in 2002. KEYWORDS: Turkish economy, financial crisis, International Monetary Fund. ********** Turkey's long-standing relationship with the International Monetary Fund (IMF) intensified at the end of the 1990s. The Turkish general election of 18 April 1999 ushered into power a new coalition government that, eight months later, sought US$4 billion assistance from the IMF and committed itself to an IMF-approved program of economic reform. Within a year, an economic crisis peaked--in November 2000 and February 2001--and the Turkish economy experienced a real terms contraction of 3.5 percent, with official unemployment doubling to 11.8 percent. (1) From January 2001 to April 2002, borrowing from the IMF increased by $23 billion. In the general election of 3 November 2002, none of the parties (government or opposition) elected in 1999 were returned. Turkey raises two questions about the IMF's interaction with the governments of emerging markets facing financial crises. First, how does IMF participation affect the policy choices available to domestic policymakers? Second, what impact does the IMF's intervention have on domestic politics in the crisis country: which actors are empowered or enfeebled, and what are the lasting consequences for domestic politics? In this study, I focus on Turkey's engagement with the IMF from November 1999 to October 2001, a period that includes three interventions by the IMF. I analyze key decisions associated with these interventions from the perspectives of the Turkish authorities and the IMF, setting out which alternatives were considered and rejected, and why. Through this analysis, I draw more general conclusions about the relationship between the IMF and Turkey. The study is based on primary materials, in the form of published communications between the IMF and Turkey, and on interviews with key decisionmakers and policymakers in Turkey, the IMF, and the G7. (2) Turkey's Engagement with the IMF Turkey's wave of economic liberalization began under the stewardship of economy (then prime) minister Turgut Ozal during 1980-1989. This period displayed twin tendencies: liberalizing reforms (including within IMF programs; see Table 1), combined with increasingly clientelistic distribution of the spoils. The decision to liberalize the capital account in 1989 was particularly significant for Turkey's fiscal position. A new source of capital allowed governments to put off unpleasant choices and delay reform. (3) A further consequence was the rapid expansion of the banking sector. In the second half of 1997, a number of officials in the Turkish economy ministries became alarmed at the direction of Turkey's underlying economic aggregates. Inflation looked set to reach 100 percent by December. At the officials' request, the IMF initiated a Staff-Monitored Program, which was announced in June 1998. The Turkish authorities were keen to move to a full program, but there was no appetite from the IMF's side, given the repeated failure to meet fiscal and structural targets set in the Staff-Monitored Program. In 1998, the poor underlying structure of the economy was further impacted by two negative shocks. …

Purpose– The purpose of this paper is to review the practicality and implications of capital controls in emerging economies in the international financial landscape subsequent to the 1997 Asian financial crisis (AFC) and the 2008 global financial crisis (GFC).Design/methodology/approach– The doctrinal approach used in this study relies primarily on primary data from relevant statutes and regulations in the capital and financial markets, and secondary data from research findings of published sources available in the public domain. It also makes concurrent use of the case study approach.Findings– The disdain over the use of capital controls by emerging economies such as Malaysia in the 1997 AFC by multilateral agencies like the International Monetary Fund (IMF) since then and particularly after the 2008 GFC and the 2011/2012 European financial crisis (EFC) has been quietly and gradually transformed into a viable policy option under defined circumstances, especially at the IMF and global forums like the G20. The 1997 AFC in particular induced East Asian economies and others to strengthen the macroeconomic and financial positions, such that they were not only able to withstand the impacts of the 2008 GFC and the 2011/2012 EFC but also contributed to their gradual recoveries through their participation as net lenders to the IMF. The enhanced confidence of these emerging economies to use various capital controls without seeking IMF support spawned new thinking at the IMF to result in the introduction of policy guidelines sanctioning the use of capital controls under particular circumstances.Research limitations/implications– The paper is constrained by the usual limitations connected with qualitative studies, but this is generally mitigated by triangulation of perspectives and so on.Originality/value– This paper provides a critical overview of the pros and cons of capital controls. In particular, it analyses the implications of capital controls as a policy option for emerging economies when facing severe financial crisis. It also critically discusses how and why flowing from the aftermath of its application by Malaysia in the 1997 AFC and subsequent employment by other successful emerging economies in response to the 2008 GFC and 2011/2012 EFC, multilateral institutions such as the IMF and international forum like the G20 developed a more positive approach toward the use of capital controls.

By the end of 2001, Argentina faced economic recession, a collapse in its banking system, and an external sovereign debt crisis. While preemptive action earlier in the year might have made one or more of these crises less severe, preemption was a political orphan at home and abroad. The country's long-standing relationship with the International Monetary Fund brought with it a mutual dependence: the IMF had come to embrace Argentina as a symbol of the success of its policy advice, and Argentina had come to rely on the IMF's endorsement and occasional financial support to navigate the choppy international markets. That relationship deepened along with Argentina's growing difficulties in the run-up to default. IMF support was used to put off a correction of the overvalued currency and to postpone a major debt restructuring. A new Argentine policy regime--and a new, more adversarial relationship with the IMF--emerged only after devaluation and default. KEYWORDS: Argentina, financial crises, banking crises, debt restructuring, International Monetary Fund. ********** Argentina's relationship with the International Monetary Fund (IMF) has been remarkably long-standing and intense. For fourteen of the twenty years preceding Argentina's crisis in 2000, its economic policy operated within an IMF program. Even after the initial success of its currency board arrangement and debt restructuring in the early 1990s, Argentina relied on the IMF's endorsement and occasional financing to navigate choppy international markets. As the IMF came under criticism for its handling of Asia's financial crisis, it set aside early doubts about Argentina's currency board arrangement and embraced the country as a symbol of the success of IMF policy advice. When external shocks left the Argentine peso overvalued at the end of the 1990s, neither Argentina's political system nor its relationship with the IMF could adjust successfully to a financial crisis that proved far deeper than either Argentina's elite or the IMF had recognized. Between 1999 and 2001, Argentina's economic slump transformed into a deep financial crisis. Two theories for Argentina's malaise dominated the policy debate. One held that Argentina was suffering from a crisis of confidence. Another held that the crisis was mostly fiscal. Both theories were too simplistic. They ignored the central importance of an overvalued currency and the heavy use of the dollar in domestic financial contracts. They also failed to recognize the extent to which the system (Argentina's currency board arrangement) had become an organizing device for Argentina's politics--not just an anchor for monetary policy--and how access to external financing had provided the critical glue that held together the political economy of convertibility. (1) Argentina's political system was unwilling to act preemptively to reduce the scale of what in many ways was an unavoidable crisis. At no time was there a political consensus to incur the costs of exiting convertibility immediately to avoid a bigger, deeper, and more costly exit later. Neither was there a consensus to shrink Argentina's economy and drive down wages and prices to abide by the constraints of a currency board, particularly once those constraints started to bite in the face of reduced capital inflows. Argentina's leaders preferred to hope that its difficulties were temporary: they drew on IMF financing, spent reserves, and then resorted to increasingly desperate attempts at financial engineering to postpone a payments crisis. Default and devaluation did not immediately bring political consensus on how to allocate financial pain. A desire to avoid probable losses transformed into an inability to allocate losses already incurred and demands for compensation from all sides. All the major players initially hoped that someone else would get stuck with the bill. The denouement of Argentina's crisis turned out to be as protracted as its buildup. …

The economic crisis in the United States and its spread to continental Europe caused a financial crisis in European stock markets, which in turn reduced production in Europe, resulting in rising unemployment, that eventually led to protests against the current economic situation. These political unrests have prompted international and regional governments and financial institutions such as the International Monetary Fund, the World Bank and the European Central Bank to find a way to end this severe financial crisis. Greece, as one of the EU member states that has been affected by this global crisis, has made efforts to improve its economic situation. The main question of this study is to what extent the International Monetary Fund was able to help resolve the financial crisis in Greece? The hypothesis is that due to the conditionality of financial aid from the International Monetary Fund to Greece in crisis and Greeces lack of attention to the full implementation of austerity programs, such financial aid has not been able to save the Greece economy from financial crisis. One of the aims of this study is to what extent developing countries can rely on IMF recommendations to overcome the financial crisis. The aim of the research is to find out why International Monetary Fund could not adopt proper monetary and financial policy to settle the financial crisis in Greece. Moreover, the reasons behind failed attempts of Greeces policymakers to implement IMFs austerity measures in their country are sought.

In the wake of the Mexican, Asian, and other crises of recent years, calls for a “new international financial architecture” have been heard from many quarters. While other questions, such as the wisdom of the International Monetary Fund (IMF) practice of long-term support for low-income countries, have also been raised, the central issue is the role that the IMF should play in reducing the likelihood of crises and in handling them once they arise, and it is this issue that is addressed in this paper. Of the other important questions, only one needs to be mentioned here. That is, in recent years, the IMF has begun paying attention to issues such as poverty alleviation, income distribution, and other questions which are not only far away from its traditional competence, but which also detract seriously from its capacity to handle macroeconomic crises, where it has possessed competence. The IMF’s ability to deal satisfactorily with the central concerns discussed here will be significantly impaired if it continues to take on these other issues. Turning then to crisis management, many suggestions have been made for changes in the IMF role. These range from its abolition to large-scale expansion of IMF resources, with many others in between. Prescription should follow diagnosis. I start, therefore, with a diagnosis as to what happened in many of the crisis countries. On that basis, I argue that there are two distinct lines along which changes could be made, and that many of the apparently conflicting demands placed upon the IMF reflect either failure to diagnose the nature of the problem or an unwillingness to come to grips with the central dilemma. Thereafter, some of the proposals currently being aired are evaluated in light of the diagnosis. The key to understanding the issues surrounding crises of the type that occurred in East Asia in 1998 lies in the proposition that most, but not all (Brazil, for example, is an exception) of the “crisis countries” of recent years have really experienced two crises almost simultaneously. They have had a balance-of-payments crisis and a financial crisis. The balance-of-payments crisis has come about as countries have been unable to maintain their obligations to foreign creditors and their commitments to maintain an exchange-rate regime. Balance-of-payments crises are familiar from earlier years, when the IMF routinely supported stabilization programs. Two characteristics of these “traditional” crises should be noted. First, efforts to defend an exchange rate and a commitment to service foreign-currency-denominated debt have almost always been precipitating factors in balance-ofpayments crises, and the solution has almost always entailed adjustment of the nominal exchange rate, if not abandonment of a fixedexchange-rate regime and adoption of a floating exchange rate. Second, key economic policymakers in the crisis country and IMF staff typically had several months in which to work out adjustment programs. In the case of the highly publicized Mexican announcement of inability to maintain debt-servicing in August 1982, for example, an IMF program was not agreed upon until many months later. Financial crises, like balance-of-payments crises, have occurred frequently in the postWorld War II period. A financial crisis comes about when the banking system is threatened with insolvency. It can occur (as in Japan in the 1990’s and in Sweden in 1992) without a balance-of-payments crisis. It is usually centered in the banking system, although the United States savings-and-loan crisis demonstrated that it can arise elsewhere in the financial system. Generally, financial crises are characterized by a large proportion of nonperforming loans (recognized or otherwise) in a country’s banks or the insolvency of other key financial institutions. * Department of Economics, Landau Building, Stanford University, Stanford, CA 94305. I am indebted to Jeffrey Frankel, Nicholas Hope, and Aaron Tornell for helpful comments on an earlier draft of this paper.

As a part of Asian governments' responses to the financial crisis of 1997-2000, corporate governance reform became an important element of the reform agenda in the crisis economies (Korea, Thailand and Indonesia) and among their neighbors. The international financial institutions (IFIs) which organized the emergency financial assistance for the crisis economies - the International Monetary Fund, World Bank and Asian Development Bank - were instrumental in the inclusion of corporate governance on the reform agenda. Yet prior to the crisis, corporate governance had not been a part of these institutions' crisis response programs, and the institutions had only limited familiarity with the issue. It was largely in response to the Korean crisis that corporate governance found its way onto the reform agenda. The dominance of the chaebol (family controlled corporate groups) had long been recognized as both a strength and as a structural weakness of the Korean economy, but previously the issue had been addressed principally through anti-monopoly and fair trade legislation and regulations. In placing corporate governance on the reform agenda in response to the financial crisis, this was the first time that corporate governance issues at the firm level were viewed as being capable of making a material contribution to the chaebol problem through greater transparency and accountability to the investing public. Such an approach also appealed to the IFIs and was consistent with the approach of the prevailing Washington consensus, in its reliance on market-driven forces rather than greater government regulation. The reform program in Korea then served as a model for comparable reforms introduced by the IFIs into the emergency assistance programs in the other crisis countries.

I. Introduction Few economic events of the past fifty years were more dramatic than the Asian financial crisis of 1997-98. Economic and political circumstances in Thailand, South Korea, Malaysia, Indonesia, and the Philippines produced severe currency depreciation and recession previously unknown to the region. While the causes and consequences of the crisis are thoroughly addressed elsewhere (for example, Woo, Carleton, and Rosario 2000; Pesenti and Tille 2000; Kamin 1999), a largely unexplored issue is the impact on food security. On the one hand, depreciation and recession make it difficult for low-income households to obtain adequate food supplies (Rosegrant and Ringler 1998; Barichello 1998; Booth 1998; Mya Than 2001). Depreciation also increases the relative price of traded goods, including most agricultural commodities, so that the crisis countries should experience increases in rural income, food production, and long-term food security (Barichello 1998; Booth 1998). A third potential issue is unique to food-importing countries. During a financial crisis, capital flight and financial contagion cause the capital account to become negative and require an offsetting surplus in the current account, assuming foreign exchange reserves are negligible. In principle, this adjustment occurs via increased export revenues or decreased import expenditures, though Higgins and Klitgaard (2000) confirm that import expenditures and import volume decreased substantially during the Asian financial crisis. If staple food imports also decrease, available food supplies would fall and harm short-run food security. A similar scenario occurs when price or production shocks increase the cost of food imports compared with available foreign exchange supplies. This article explores the connection between foreign exchange supplies, food security, and the financial crisis of 1997-98 in Indonesia and the Philippines. Of all the Asian crisis countries, Indonesia and the Philippines are examined separately because of their low per capita incomes and vulnerability to short- and long-term food insecurity. Both countries are also highly dependent on cereal consumption and are net cereal importers, with food grains comprising the bulk of cereal imports. Section II of the article reviews prior studies regarding balance of payments shocks and food security. Section III constructs a working definition of food security and examines the specific conditions in Indonesia and the Philippines. The methodology, data, and regression model are described in Section IV, followed by estimation results in Section V. The article concludes with implications for food security and balance of payments policies. II. Background Previous studies of foreign exchange supplies and food security primarily address compensatory financing issues. Compensatory financing allows countries experiencing short-term food shortages to obtain foreign exchange for food imports at favourable terms from the International Monetary Fund (IMF) or other institutions. Valdes and Konandreas (1981) show that countries not normally dependent on food imports must occasionally use a significant share of their export revenues for food imports during price or production shocks. Goreux (1981) explains how the IMF's compensatory scheme for stabilizing export revenues from the 1970s could be modified to accommodate cereal imports during consumption shortfalls. (1) Huddleston et al. (1984) examine the IMF's Compensatory and Contingency Financing Facility (CCFF) and find potential for offsetting temporary and sudden food import shocks. Others are less supportive of the CCFF (Green 1983; Green and Kirkpatrick 1982; Kumar 1989; Diakosavvas and Green 1998), arguing that it gives too much attention to stabilizing export revenue and insufficient attention to food consumption. An implicit question in the above studies is whether foreign exchange supplies actually constrain food imports. …

The International Monetary Fund (IMF), conceived at the Bretton Woods conference in July 1944, has become the focal point of the international monetary system. Created in 1946 with 46 members, it has grown to include 184 countries. The IMF has six purposes that are outlined in Article I of the IMF Articles of Agreement. They are the promotion of international monetary cooperation; the expansion and balanced growth of international trade; exchange rate stability; the elimination of restrictions on the international flow of capital; insuring confidence by making the general resources of the Fund temporarily available to members; and the orderly adjustment of balance of payment (BOP) imbalances. At the Bretton Woods conference, the IMF was tasked with coordinating the system of fixed exchange rates to help the international economy recover from two world wars and the instability in the interwar period caused by competitive devaluations and protectionist trade policies. From 1946 until 1973, the IMF managed the 'par value adjustable peg' system. The U.S. dollar was fixed to gold at $35 per ounce, and all other member countries' currencies were fixed to the dollar at different rates. This system of fixed rates ended in 1973 when the United States removed itself from the gold standard. Floating exchange rates and more open capital markets in the 1990s created a new agenda for the IMF - the resolution of frequent and volatile international financial crises. The Asian financial crisis of 1997-8 and subsequent crises in Russia and Latin America revealed many weaknesses of the world monetary system. To better help it achieve its overall goal of promoting a stable international monetary system, the IMF's format has changed dramatically since it was created in 1945. Designed initially to provide short-term balance of payments (BOP) lending and monitor member countries' macroeconomic policies, the IMF has steadily incorporated microeconomic factors such as institutional and structural reforms into its activities. These had been seen previously as the exclusive province of the World Bank and other development agencies. The IMF found that, in order to pursue its core responsibilities in the changed world economy, it needed to pay greater attention to second generation reforms, as economists call these sorts of issues. IMF member countries agreed on a quota increase in 1997. The U.S. Congress subsequently appropriated additional funding for the IMF in October 1998 in the midst of the Asian financial crises, a decision that engendered considerable debate in light of growing criticism of the IMF and its lending practices. In 2002, the IMF did not request any additional increase in funding. Although appropriations of new funds for the IMF is not pending, Congress exercises oversight authority over U.S. policy at the IMF and over its lending practices. This report supports congressional oversight of the IMF by providing an understanding of its organization, functions, and role in the world economy. This report will be updated only if major events and new developments require.

Previous articleNext article FreeOn Graduation from Default, Inflation, and Banking Crises: Elusive or Illusion?Rong Qian, Carmen M. Reinhart, and Kenneth RogoffRong QianUniversity of Maryland Search for more articles by this author , Carmen M. ReinhartUniversity of Maryland and NBER Search for more articles by this author , and Kenneth RogoffHarvard University and NBER Search for more articles by this author University of MarylandUniversity of Maryland and NBERHarvard University and NBERPDFPDF PLUSFull Text Add to favoritesDownload CitationTrack CitationsPermissionsReprints Share onFacebookTwitterLinked InRedditEmailQR Code SectionsMoreI. IntroductionThis paper addresses the concept of "graduation" from external default, banking, and inflation crises.1 Employing a vast data set cataloging more than 2 centuries of financial crises for over 60 countries developed in Reinhart and Rogoff (2009), we explore the risk of recidivism across advanced economies versus middle- and low-income countries. We show that 2 decades without a relapse (falling into crisis) is an important marker. After 1800, roughly two-thirds of recurrences of external default on sovereign debt and three-quarters of recurrence of inflation crisis occur within 20 years.2 However, crisis recidivism distributions have very fat tails, so that it takes at least 50 and perhaps 100 years to meaningfully speak of "graduation." Indeed, in the case of banking crises in particular, it is hard to argue that any country in the world has truly graduated.Given that graduation (with its companion question, will this ever happen again?) is arguably one of the most important issues in macroeconomics and development, there has been remarkably little theoretical or empirical investigation of the subject. For example, the large theory literature on sovereign lending and default, while producing many important insights into the fundamental distinction between willingness to pay and ability to pay, largely treats a country's basic developmental and political characteristics as parametric. There is very little on explaining the political, social, economic, and financial dynamics that ultimately lead a country to be less prone to certain types of crises.We acknowledge that the concept of graduation is a hard nut to crack. Many advanced countries had enjoyed a long hiatus from systemic banking crises after World War II and yet had huge problems during the recent global financial crisis. After 90 years of serial default running from 1557 to 1647, Spain did not default again until 1809. Even the advanced countries had high inflation as recently as the 1970s and early 1980s, while many emerging markets had hyperinflation less than 2 decades ago. Is the advent of modern independent central banks sufficient to guarantee that fiscal dominance never again reasserts itself? Have the rich countries that have supposedly "graduated" from serial default on external debt shifted the locus of risk to de jure or de facto (via inflation or financial repression) default on domestic debt? Does the theory of sovereign default or of financial development tell us that we should expect richer and more advanced countries to be immune? Or is graduation a mirage, with the "graduates" really being at best "star pupils," and can graduates be distinguished from patients in remission?Our goals in this paper are fairly narrowly circumscribed. Most of our analysis is based on data on the dates and duration of the crises themselves. We speculate on underlying causal factors but do not approach them empirically here.3 Although the various types of crises often occur in clusters, our quantitative analysis mainly treats individual crises separately.We begin the paper in Section II by defining the crises that we will catalog. In Section III of the paper, we present a summary time line of crisis, followed by a brief overview of the early history of serial default on external debt. An interesting case is France, which defaulted on its external debt no fewer than nine times from the middle of the sixteenth century through the end of the Napoleonic War but has not defaulted on external debt since. France is a canonical case of what we define as an "external default graduate." (This did not stop France from having numerous severe banking crises in the past 2 centuries.)In the main body of the paper, we provide a broad aggregative historical overview of the data across different types of crises, distinguishing between advanced countries and emerging markets, also taking into account the advent of International Monetary Fund (IMF) programs after World War II as another marker of a debt crisis.In Section IX of the paper, we speculate on links between graduation and development and the possibility for recidivism among richer countries. The fact that the canonical theory of sovereign default does not strongly predict smaller problems in richer countries (it does not strongly predict graduation) might be considered a flaw in theory. But it might also be taken as warning sign that graduation can be more difficult and take even more time than our data of "just" a few centuries can reveal. On banking crises, the theory needs to better explain why countries never seem to graduate.The main empirical results from our long-dated historical time series on financial crises may be described as follows. First, the process of "graduation," that is, emergence from frequent crisis suffering status, is a long process. False starts are common and recurrent. This is especially true in the case of banking crises, for both high-income countries and middle- and low-income countries.Second, the vulnerability to crisis in high-income countries versus middle- and low-income countries differs mostly in external default crises, to a lesser extent in inflation crises, and surprisingly little in banking crises.4Third, the sequence of graduation for most countries is first to graduate from external default crisis, then from inflation crisis, and eventually from banking. The last stage of graduation is extremely difficult, even for high-income countries. Among high-income countries, even though most of them have graduated from external default crisis and inflation crisis, more than 20% recently experienced a banking crisis, and far more when weighted by size. Schularick and Taylor (2009) speculate that advanced countries continue to experience credit busts despite arguably advancing regulation and institutions, because as risks moderate, financial systems grow and restore them.Finally, the role of IMF programs in crises in the modern period is important. The availability of IMF bridge loans certainly has increased countries' resilience to "sudden stops" but, even setting aside moral hazard problems, is by no means a cure-all. Countries entering IMF programs are still forced to undergo painful macroeconomic adjustments in an attempt to regain sound fiscal footing and regain access to private capital markets. The challenges of successfully implementing IMF programs are underscored by the fact that there are many significant cases in which countries default within 3 years of an IMF bailout. IMF programs may help facilitate orderly debt workouts but do not guarantee them. We also note that in its early history, many of today's rich countries regularly drew on IMF resources, although there has been a 3-decade hiatus.II. Definition of CrisesExternal debt crisis. We distinguish between external and internal debt on the basis of the legal jurisdiction where the debt contracts are enforced. This is a convenient construct given the history and evolution of sovereign debt. Obviously it may be useful to parse the data in other ways for some exercises, and in principle our data set allows that.Although there are exceptions and there has been some evolution in recent years, typically in our long-dated historical data set, external debt is denominated in foreign currency and held by foreign creditors. There are certainly important examples, such as Mexico's short-term Tesobono bonds in the mid-1990s, where the debt is domestic yet is denominated in foreign currency and held primarily by foreign creditors. Although we regard the U.S. abrogation of the gold clause in the early 1930s—when gold was revalued from $21 to $35 per ounce—to be a default on domestic debt, many non-U.S. residents were also holding the debt at the time. In general, following standard practice, we define an external debt crisis as any failure to meet contractual repayment obligations on foreign debts, including both rescheduling or repayments and outright default. (As both of these examples make clear, however, one ultimately needs to think carefully about whether graduation from external default may sometimes just mean a shift to episodic de facto and de jure internal default.)In practice, most defaults on external debt end up being partial, with creditors typically (but not always) repaying 30¢–70¢ or more on the dollar, admittedly not adjusting for risk. The rationale for lumping together defaults regardless of the ultimate "haircuts" creditors are forced to absorb is that, in practice, the fixed costs of external debt default (which include difficulties in obtaining trade credits and loss of reputation) tend to be large relative to the variable costs. In principle, one could parse episodes more finely here according to, say, output or tax revenue loss depending on data availability, although we do not undertake that exercise here. See, however, Tomz (2007) and Tomz and Wright (2007).Inflation crises. Following Reinhart and Rogoff (2004), we define inflation crises as episodes in which annual inflation exceeds 20%. This threshold is lower than the 40% we and others have used in related studies on postwar data but is a compromise reflecting that prior to World War I, average inflation rates were much lower, and 20% inflation generally represented a significant level of dysfunction. Indeed, since we are particularly interested here in inflation as a vehicle for partial default, one clearly would also want to consider lower levels of sustained unanticipated inflation such as many advanced countries experienced in the 1970s. Depending on the maturity structure of debt, sustained 10% inflation can certainly be tantamount to de facto default. A proper calibration, however, would require detailed data on the maturity structure of debt (as in Missale and Blanchard 1994) and, ideally, also on the evolution of inflation expectations. We do not attempt this here, though again, this is an important caveat to interpreting the concept of graduation from external debt crises.Banking crises. Our definition of banking crises follows standard practice (e.g., Kaminsky and Reinhart 1999; Caprio and Klingebiel 2003). Following our own earlier work, "We mark a banking crisis by two types of events: (1) bank runs that lead to the closure, merging or takeover by the public sector of one or more financial institutions and (2) if there are no runs, the closure, merging, takeover, or large-scale government assistance of an important financial institution (or group of institutions) that marks the start of a string of similar outcomes for other financial institutions" (Reinhart and Rogoff 2009, 11). We recognize that our listing of systemic (on a national scale) banking crises may be incomplete, especially prior to 1970, especially for crises outside the large money centers that attract the attention of the world financial press.5Having set out basic definitions, we are now ready to view some basic characteristics of the data. To provide context and motivation for the concept of graduation, we begin with a summary time line of financial crises since 1550, followed by a brief overview of the early history of sovereign defaults.III. A Time Line of Financial Crises and the Early History of Sovereign DefaultsTable 1 provides a summary historical perspective that helps show how the three different varieties of financial crisis have spread over time and across country groups. Between 1550 and 1800, sovereign defaults on external debt were relatively common in Europe, but they were relatively rare elsewhere if only because (a) there were few other independent nations in a position to default and (b) given the crude state of global capital markets, relatively few countries were wealthy enough to attract international capital flows. Thus defaults were relatively insignificant in the regions that constitute today's emerging markets. Systemic banking crises, however, were relatively rare everywhere. The legal and technological underpinnings of modern private banking simply had not reached a stage of maturity and depth sufficient to cause systemic crises in most instances. (Of course, there are exceptions. Following Cipolla [1982] and MacDonald [2006], Reinhart and Rogoff [2009] discuss how England's 1340 default to Florentine bankers triggered a financial crisis in Italy.) Similarly, inflation crises were relatively rare, although again there are many exceptions (see Reinhart and Rogoff 2009, chap. 12). Prior to the widespread adoption of paper currency, bouts of very high inflation were relatively difficult to engineer.Table 1. Time Line of Crises, 1550–2010 External DebtCrisesBanking CrisesInflation Crises1550–1815 (Napoleonic wars end)Frequent in advanced economies (including the "world powers" of the time); serial in some casesRareRare1826Frequent in "peripheral" advanced economies and most emerging marketsSerial in advanced; rare in emergingRare18501900Serial in advanced; more frequent in emerging1913 (WW1 begins)Frequent in advanced and emerging1945 (WWII ends)Rare in advanced and emergingPost-1945Rare19641973Serial in some emerging marketsMore frequent in advanced; serial in emergingFrequent in advanced and emergingEarly 1980sEarly 1990sFrequent in emerging2000Rare20092010??View Table ImageThe end of the Napoleonic War in the early 1800s marks a significant transition. The largest advanced countries were increasingly able to avoid external default, albeit partly by their ability to issue an increasing share of their debt domestically. Default, however, became common in "peripheral" advanced countries such as Spain and Portugal, while newly independent emerging markets such as Greece and Latin America entered a long period of serial default. Over the same period, as advanced countries developed more sophisticated banking systems, banking crises became far more common. Emerging markets were certainly affected by advanced country banking crises but did not have so many of their own, if only because their financial systems were dominated by foreign banks.By the turn of the twentieth century, emerging market financial institutions had developed to the point where domestic banking crises became more common. By the time of the Great Depression of the 1930s, banking crises were a worldwide phenomenon. Owing in no small part to the financial repression that followed in reaction to the Great Depression, banking crises were relatively rare during the period from the end of World War II until the early 1970s. As financial repression thawed, banking crises became more frequent in the advanced economies and serial in many emerging markets, bringing us to the recent financial crisis episode.Finally, Table 1 gives a time line of inflation crises, which of course were quite common in all countries in the 1970s and remained a problem in emerging markets until the past decade.We thus focus our early history on sovereign external defaults. As Reinhart et al. (2003) and Reinhart and Rogoff (2009) emphasize, many of today's advanced economies had recurrent problems with default on sovereign debt during the period when they might arguably have been characterized as emerging markets. Table 2 illustrates the case of Europe for the 3-century period 1550–1850, with the years listed marking the beginning of a sovereign default episode.Table 2. External Defaults: Europe, 1550–1850CountryYears of DefaultNumberof DefaultsAustria-Hungary1796, 1802, 1805, 1811, 18165England*1594*1*France1558, 1624, 1648, 1661, 1701, 1715, 1770, 1788, 18129Germany: Prussia1683, 1807, 18133 Hesse18141 Schleswig-Holstein18501 Westphalia18121Netherlands18141Portugal1560, 1828, 1837, 1841, 18455Russia18391Spain1557, 1575, 1596, 1607, 1627, 1647, 1809, 1820, 1831, 184310Sweden18121Source: Reinhart et al. (2003), Reinhart and Rogoff (2009), and sources cited therein.Note: The table excludes Greece (which gained independence in 1829). Note that for some countries, even if there was a default on external debt, there may have been a default on domestic debt, as was the case for Denmark (1813).* Denotes our uncertainty at this time about whether England's default involved external (as opposed to purely domestic) debt.View Table ImageAs one can see clearly from the table, serial default was quite common among the major European powers during the sixteenth through nineteenth centuries, with France defaulting on its external debt nine times and Spain defaulting 10 times (with three more to follow in the second half of the nineteenth century). One important observation, immediately apparent from the table, is that there is typically a substantial interval between defaults, typically decades, but sometimes centuries. (Note that we require at least 2 years between default episodes to regard them as independent events.) After defaulting in 1683, Prussia's next default episode did not follow for more than a century in 1807. Portugal, after defaulting in 1560, did not default again until 1828, when the country lapsed into a period of serial default that did not end until 1890. At this writing, Portugal has not defaulted again since. (Importantly, during a significant portion of Portugal's quiescent period, it had effectively lost its independence.)Figure 1 gives a measure of the duration of periods of recidivism during the pre-Napoleonic era for the independent (relatively) high-income countries of our sample. The the of time between default episodes (including cases in which there was no As one can see from the half of all default recurrences after a more than with a significant even after a 1. External default duration of high-income countries, of time is as the of years between two external We first the of external default then the duration of time if it was and the episodes of default crisis with and two episodes with no countries Portugal, and Reinhart and Rogoff (2009), sources cited and country external sovereign debt defaults have much in the modern most recent default in in and in (Reinhart and Rogoff interesting are the cases of and France, despite a level of defaults in its pre-Napoleonic has not defaulted on external debt since. has not defaulted on external debt since its default at the end of the Napoleonic War in would be interesting to explore whether defaults are less to than defaults, though of course over many it is the to that many countries to up large (as in the of we will consider the of our recidivism results to the of and Rogoff (2009) also show that the of long in Table 2 are quite of some of today's emerging markets, many of which have defaulted at least during the past The of emerging markets that have experienced external debt crises if one episodes in which countries default to IMF bridge In all these the countries still as were forced to fiscal as we do not include these in our although arguably from the point of view of macroeconomic and the of debt they are important. We to this issue when we IMF The and of Crises: The now to focus on the more period, to the at the same time the analysis to include banking and inflation crises, as in Table as important in this The past 2 centuries also a much of independent nations to as various regions of the world the of In Table we present of crisis measure takes the of years a country experienced of crisis (including all years and not just the by the of years since independence (or since of External and low-income Reinhart and Rogoff (2009), sources cited and is as the of years in crisis by the of years since were for country since or the country's independence countries for external default crisis and countries for inflation and banking Latin Table 3 that the between high-income countries and the of the world in to external default crisis. The average external default crisis of the high-income group is less than half of that of middle- and low-income countries and of that of Latin countries. The would be even if we only and defaults. crisis are also in the of the world than in high-income countries although the is the average of banking crises in high-income countries and in the of the world are The results in Table 3 of course, with the time line in Table that inflation and banking crisis are lower in part because the average duration of these crises to be much to external default crises. (Note also that we are years in crisis, as opposed to the of independent Table which gives the average duration of crises, the between the mean and duration of external default crises versus inflation and banking crises. The duration of banking crises is 3 years or less across all where the world for default crises is For inflation crises, the is only 1 across all this that a country can ways to on in a state of sovereign default far more than it can continue any of as during a banking or inflation the long duration of external default crises and their it is not that large of the world have been in default over much of the last years, as by Reinhart and Rogoff of the major default episodes include the Napoleonic in the early nineteenth century and then Latin countries and Portugal in the first of the The default during the era that the Great Depression and World War when at the more than 40% of the weighted by was in default on external 2 gives the share of countries in inflation crisis over the same Note the huge in inflation crises after World and II and again in the and early The very recent history of inflation most of the world a major shift from the to be whether inflation is a that has been As Rogoff (2003) has including especially the advent of independent central banks with a have been an important in this in but so was the that political on central banks to in unanticipated to be whether the period will another many in as opposed to a shift and 2. Share of countries in inflation crisis, countries that were independent in the given Reinhart and Rogoff (2009), sources cited and if one truly that fiscal dominance will never again in most countries, historical of outright default may the true the of default inflation has been effectively The recent of public debt this 3 gives the share of the world banking crises since Note the remarkably small of banking crises during the years of financial repression that during World War II and in many countries into the 1970s. By historical this was a quiescent is also from the that this era has been long but to be to an Share of countries in banking crisis, countries that were independent in the given Reinhart and Rogoff (2009), sources cited and next three the of high-income countries with of middle- and low-income countries (including Latin what we have in Table 3 but more on external debt crises, for example, illustrates two First, as middle- and low-income countries are in default on external debt a of the time than high-income countries. high-income countries had a in external defaults in the with (as of this since the advent of rates in the 1970s. we at on since the last default crisis. We from our middle- and low-income countries very low-income countries that do not have external default by of the fact that they are not able to at all on private Share of countries in external default crisis, high-income versus middle- and low-income countries. countries high-income and middle- and low-income that were independent in the given Reinhart and Rogoff (2009), sources cited and countries seem to have graduated from default crisis, or at least into But most middle- and low-income countries have not yet the of inflation crises in middle- and low-income countries versus high-income countries. countries have had inflation crises more recently than external default crises, but the has to since the early For middle- and low-income countries, a in the has been followed by a during the is of the of very high inflation we note that it does not episodes of sustained high inflation 20% that, if unanticipated and depending on the maturity structure of government debt, may a substantial de facto default on domestic Share of countries in inflation crisis, high-income versus middle- and low-income countries. countries high-income and middle- and low-income that were independent in the given Reinhart and Rogoff (2009), sources cited and on banking crises a very different data for countries begin more the line for middle- and low-income countries only in the course, many of today's countries did not their independence until One can see that in to external default and inflation crises, banking crises are (Reinhart and Rogoff 2009, chap. Although banking crises have up in

I. Lessons from and Responses to the East Asian Financial Crisis The East Asian financial crisis of 1997-98 provides several valuable lessons for all parties concerned, including governments, the private sector, and international financial institutions that came to the region's rescue. It highlights how vulnerable small, open (capital account) economy is to an adverse shift of capital flows. It also demonstrates how quickly investors' confidence can erode and how their panic can spread contagion to neighbouring countries. The international financial rescue of 1997-98 came in slightly too late, and its initial liquidity support was too small to provide sufficient cushion for the magnitude of capital outflows. The rescue consequently failed to calm the market, resulting in continued outflows of capital and depreciating exchange rates. Policy prescriptions also failed to recognize the negative effects of austerity measures imposed on the already worsening economies and the welfare of their people, plunging crisis-affected countries deeper into recession. (1) As noted by Bird and Rajan (2001), there exists trade-off between the severity of adjustment in the short run and the availability of international liquidity in the event of crisis. In particular, the shortage of liquidity led to quicker and more intensive economic adjustment that resulted in much larger output losses compared with previous crises. In August 1997, Japan, together with several ASEAN countries, proposed the idea of an Asian Monetary Fund (AMF) to provide financial support for Thailand. It aimed to raise US$50 billion to US$60 billion from six ASEAN countries, Korea, China, Hong Kong, and Taiwan, and another US$50 billion from Japan. It was designed to be independent and would take up some IMF activities, such as regional surveillance. (2) However, the AMF proposal never got off the ground due to strong opposition from the United States and the International Monetary Fund (IMF). It was argued that such an arrangement would both create problem of moral hazard and, in competing with the IMF, double standard. (3) II. The Manila Framework A similar idea but significantly toned down--and with recognition of the IMF's central role in the international monetary system--emerged few months later when ministry of finance and central bank deputies of fourteen Asia-Pacific economies met on 18-19 November 1997 in Manila to discuss concerted approach to restoring financial stability in the region. (4) They came up with new initiatives under the so-called Manila Framework, that included regional surveillance and regional financing arrangement. In particular, the Framework called for: 1. mechanism for regional surveillance to complement the global surveillance of the IMF; 2. enhanced economic and technical co-operation, particularly in strengthening domestic financial systems and regulatory capacities; 3. measures to strengthen the IMF's capacity to respond to financial crises; and 4. co-operative financing arrangement that would supplement IMF resources. The announcement made on 19 November 1997, which is an agreed summary discussion of the meeting, highlighted the need for the IMF to quickly mobilize its financial assistance on a scale sufficient to restore market confidence. (5) In that context, the deputies also agreed to explore ways to supplement IMF and other international financial institution resources through cooperative financing arrangement in the region. III. The ASEAN Surveillance Process At their special meeting in Kuala Lumpur few weeks later, the ASEAN finance ministers concurred with the proposals of the Manila Framework and decided to implement it. The first initiative of the Framework--a mechanism for regional surveillance--was deliberated further at the Second ASEAN Finance Ministers Meeting (AFMM) on 28 February 1998 in Jakarta, where it was agreed that the ASEAN surveillance mechanism should be established immediately, within the general framework of the IMF and with the assistance of the Asian Development Bank (ADB). …

The role of international financial institutions is recognized in the modern world and even today the global world depends on the finances of financial organizations, because they play a major role in the accumulation, availability and distribution of finance, and some international financial organizations help publicly And has become an essential aid component at the modern stage, especially during the Kovid-19 pandemic and the Russia-Ukraine conflict. International financial organizations are often cited as the world's most powerful agents of economic reform (Halliday and Carruthers, 2007:1135-1202). The role of international financial organizations is also special for Georgia, it can be said for developing countries in general, of course developed countries are not excluded, but access to finance and technical assistance is often needed by poor, transition or developing economies. The role of international financial organizations increased especially after the Second World War, in fact, in 1944, and the Bretton Woods Conference is considered the birthplace of international financial organizations, as there were no such financial organizations before, however, the formation of such organizations Financial condition. We will not discuss the origins of organizations in this topic, but it should be noted that the International Monetary Fund and the World Bank, established under the Bretton Woods Conference, are still major players in the process of globalization and economic rapprochement with various international or regional financial organizations. At the same time, the International Monetary Fund is constantly introducing new standards in the face of modern challenges and adapting in the face of crises and challenges, assisting in implementation and conducting monetary policy, of course, taking into account the specifics of the country. It should also be noted that the opinion of scientists and experts often does not coincide with the policies of international financial organizations, even the International Monetary Fund in some cases, because local factors are ignored, which will be discussed in the main text, according to some examples. As for the World Bank Group, it mainly accredits countries with various types of loans and often plays an important role in stimulating the economy of a particular country - by financing infrastructure, energy and investment projects. It should be noted that intercity and urban infrastructure in Georgia is mainly financed by international financial organizations, including the construction of highways, municipal infrastructure, drainage systems, sidewalks and municipal transport development (For example, KFW-funded projects are important for the city of Batumi). The Asian Development Bank mainly finances the construction of the Central Highway, etc. Of course, such list is much broader and a matter of separate research, but we understand that it would be difficult for the state to finance such projects only with its own funds, and the already protracted projects would be further extended. Although international financial institutions play an important role in stimulating the economy, criticism often comes from the IMF's monopolistic and linear monetary policy, for example, the crisis of Asia in the 1990s and South Korea, when the IMF imposed its rule on South Korea. The policy developed by the experts, which should have been mainly focused on fighting inflation, which in fact deepened the crisis and led South Korea to default, which affected the entire financial market and particularly harmed private farms - small and medium-sized enterprises. The role of international financial organizations is special for Georgia as well, because the IMF and other international financial organizations play an important role in stimulating the Georgian economy, as most of the loans are directed to infrastructure and budget support loans. The volume of GDP and the level of employment of the population, however, the results of the funded projects will be more effective for the state and the population in the future. Debt management and services remain a challenge when financing international organizations, as the existence of public debt has historically been problematic, and the IMF has repeatedly called on states to maintain adequate levels of debt. However, it should be noted that the IMF at the present stage pursues a policy of relatively open governance and takes into account the characteristics of states in their monetary policy, because in the light of the crises of recent years, the Fund was not open to such governance. t should be said about the practice of Georgia, Georgia does not have a bad practice in terms of debt management, however, the debt volume as of 2021 is within 52% of GDP At the same time, it remains a challenge for Georgia to effectively implement projects financed by international financial organizations on time, because it is difficult to talk about the effectiveness of projects delayed over time. At the same time, it is important for Georgia to receive more loans from such organizations to finance more infrastructure and necessary economic projects.