Abstract
This paper shows how fiscal imbalance and excessive external borrowing may lead to a financial crisis. The trigger of the crisis is substantial increase in risk premium as a result of persistent budget deficits. This results in hyper depreciation of exchange rate, which causes an adverse balance sheet effect on investment in the presence of external commercial borrowings. This leads to a contraction of output and the country enters into recession. Furthermore, policy prescriptions are provided to curtail the crisis. The situation in Argentina is analysed in the light of this model.
Highlights
A financial crisis is a phenomenon associated with substantial changes in volumes of credit and asset prices
We extend the model of third generation crisis and introduce risk premium in it
An increased risk premium causes a depreciation of the exchange rate and reduces investment, which dominates the rise in net exports
Summary
A financial crisis is a phenomenon associated with substantial changes in volumes of credit and asset prices. An open economy theoretical model has been constructed to explain the boom burst cycle experienced in most episodes of financial crisis including the Greek crisis. A deterioration of budget deficit may lead to a demotion of credit rating and a rise in risk premium. This in turn causes an increase in exchange rate.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
