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Financial Crises, Liquidity, and the International Monetary System

Financial Crises, Liquidity, and the International Monetary System

Jean Tirole
Copyright Date: 2002
Pages: 168
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  • Book Info
    Financial Crises, Liquidity, and the International Monetary System
    Book Description:

    Once upon a time, economists saw capital account liberalization--the free and unrestricted flow of capital in and out of countries--as unambiguously good. Good for debtor states, good for the world economy. No longer. Spectacular banking and currency crises in recent decades have shattered the consensus. In this remarkably clear and pithy volume, one of Europe's leading economists examines these crises, the reforms being undertaken to prevent them, and how global financial institutions might be restructured to this end.

    Jean Tirole first analyzes the current views on the crises and on the reform of the international financial architecture. Reform proposals often treat the symptoms rather than the fundamentals, he argues, and sometimes fail to reconcile the objectives of setting effective financing conditions while ensuring that a country "owns" its reform program. A proper identification of market failures is essential to reformulating the mission of an institution such as the IMF, he emphasizes. Next he adapts the basic principles of corporate governance, liquidity provision, and risk management of corporations to the particulars of country borrowing. Building on a "dual- and common-agency perspective," he revisits commonly advocated policies and considers how multilateral organizations can help debtor countries reap enhanced benefits while liberalizing their capital accounts.

    Based on the Paolo Baffi Lecture the author delivered at the Bank of Italy, this refreshingly accessible book is teeming with rich insights that researchers, policymakers, and students at all levels will find indispensable.

    eISBN: 978-1-4008-2852-4
    Subjects: Business

Table of Contents

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  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. Acknowledgments
    (pp. vii-viii)
  4. Introduction
    (pp. ix-xiv)

    A wide consensus had emerged among economists. Capital account liberalization – allowing capital to flow freely in and out of countries without restrictions – was unambiguously good. Good for the debtor countries, good for the world economy. The twofold case for capital mobility is relatively straightforward: First, capital mobility creates superior insurance opportunities and promotes an efficient allocation of investment and consumption. Capital mobility allows households and firms to insure against country-specific shocks in worldwide markets; households can thereby smooth their consumption and firms better manage their risks. Business cycles are dampened, improved liquidity management boosts investment and promotes growth. Second, besides...

  5. 1 Emerging Markets Crises and Policy Responses
    (pp. 1-22)

    Many excellent books and articles have documented the new breed of “twenty-first century” financial crises.¹ I will therefore content myself with ashort overviewof the main developments. This chapter can be skipped by readers who are familiar with Emerging Markets (EM) crises.

    No two crises are identical. At best we can identify a set of features common to most if not all episodes. Let us begin with a list of frequent sources of vulnerability in recent capital-account crises.

    Size and nature of capital inflows.The new breed of crises was preceded by financial liberalization and very large capital inflows....

  6. 2 The Economists’ Views
    (pp. 23-46)

    Many of the best minds among economists and the financial community have expressed their views on recent international financial crises and the design of a new financial infrastructure.¹ While there is widespread agreement on what happened, there is much less convergence on what should be done about it. Still, we can identify a common core of proposals (together with, as usual, a few dissenting voices), as well as a number of issues on which economists disagree. Abusing terminology, let us call the former the “consensus view”.

    The seven pillars of the consensus view

    Most recommendations concur on a number of...

  7. 3 Outline of the Argument and Main Message
    (pp. 47-52)

    The discussion in Chapter 2 is shadowed by a lingering question: What are we trying to do? Preventing crises is not a goal in itself; after all, prohibiting foreign borrowing would eliminate the threat of foreign debt crisis altogether! The issue therefore is, how desirable are specific policies when trying to accomplish a well-stated, unambiguous objective?

    In this respect, I am struck by the fact that proposals for a new international financial architecture rarely formulate a clear objective function. Or else, and almost equivalently, they offer a whole array of objectives: avoid financial crises, resolve them in an orderly manner,...

  8. 4 Liquidity and Risk-Management in a Closed Economy
    (pp. 53-76)

    A central question addressed in this book is the extent to which a country resembles or differs from an ordinary borrower. To set the stage, we therefore need to recap the main features of financing agreements. My coverage of corporate financing will be sketchy and highly selective, and will focus on the themes that are most relevant to the subsequent chapters. For obvious reasons, I will put special emphasis on control rights and liquidity and risk management issues. I will then discuss the notion and the role of domestic liquidity¹ before turning to the international context in the next chapter....

  9. 5 Identification of Market Failure: Are Debtor Countries Ordinary Borrowers?
    (pp. 77-96)

    The proposals reviewed in Chapter 2 are direct transpositions of basic principles of capital adequacy, liquidityand risk-management, and governance for corporations and financial institutions. Yet, while countries are often identified with corporate units with which they should share governance and financing principles, it is also frequently declared that countries have special features that somehow make them different. This chapter assesses these objections and then formulates the premises for my own perspective. I will argue that countries are indeed different, but the reasons I will emphasize differ from the usual ones.

    Debtor countries are similar to ordinary borrowers in many respects....

  10. 6 Implications of the Dual- and Common-Agency Perspectives
    (pp. 97-112)

    This chapter derives the implications of the market failure identified in Chapter 5. Government moral hazard limits a country’s access to financing. The country’s government is an agent common to all foreign investors in both sovereign and, owing to the dual-agency structure, private sector borrowing. The country’s access to more and better forms of financing is enhanced if the commonagency problem is alleviated through the introduction of a “delegated monitor”; and if public policies address the market failure rather than the symptoms. Lastly, the need for a delegated monitor and the nature of the policies differ across countries according to...

  11. 7 Institutional Implications: What Role for the IMF?
    (pp. 113-128)

    This chapter discusses the two fundamental (and hotly debated) questions concerning the International Monetary Fund: its mission and its governance. As we will see, the two questions are not unrelated.

    The IMF’s original mission, defined in Bretton Woods in 1944, was to support a system of “pegged-but-adjustable” exchange rates. At the time, tight restrictions on capital mobility brought balance-of-payments issues to the fore. The IMF accordingly, and for many years, emphasized oversight of fiscal and monetary policies. Its customers could well be developed countries (for example, Italy in 1964 and the United Kingdom in 1967). And limited capital mobility implied...

  12. 8 Conclusion
    (pp. 129-130)

    To conclude, let me review the book’s argument:

    The lack of a clear mission for the IMF, and the current focus on symptoms rather than disorders, both suggest that we should return to identifying the underlying market failure.

    The market failure emphasized in this book stems from the absence of contracting with the government, notwithstanding the fact that the latter has many subtle and not-so-subtle ways of affecting the return to foreign investors.

    In order for the country to have access to more and better financing, foreign investors need to be represented. The IMF could therefore act as a delegated...

  13. References
    (pp. 131-144)
  14. Index
    (pp. 145-151)