Financial Crises, Liquidity, and the International Monetary System
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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.
its government, I call this the dual-agency problem (Figure 4). 49 OUTLINE OF THE ARGUMENT AND MAIN MESSAGE Foreign investors 0 0 - .......... - ········-·- -·-··-··r-=-c---. ( Government) '] '------······················-- -- ··············---·-·························· ... Common agency perspective. Sovereign borrowing Dual agency perspective. Private sector borrowing --~------~-----~0 0'-: (0 I I Foreign investors Private borrowers (Government) Dual- and common- agency
On the recipient side, 5 borrowing by the public sector has shrunk 2 For such a signal to be credible, though, a government that is conunitted to capital-account liberalization must find it less costly to lift controls on capital outflows than a government that is not conunitted. See Bartolini-Drazen (1997) for a formalization of this idea. 3 World Bank (1997). 4 World Bank (1997). 5 See Gourinchas et al (1999) for evidence on lending booms. Among other things, this paper suggests that lending
funding" and "financiers" in corporate finance. As in the case of corporate financing, there is a wedge between the projects' NPV and the income that can be pledged to foreign investors. That is, investors may 78 CHAPTER 5 not be able to put their hands on all the proceeds attached to their investment. Part of the reason is the same as for corporations: insiders enjoy private benefits and, further, must be given incentives to behave. But part of the reason is specific to the international
is external borrowing different? Institutional and policy responses to market failure 47 48 48 50 36 36 4. Liquidity and Risk-Management in a Closed Economy 53 Corporate financing: key organizing principles 53 Domestic liquidity provision 70 5. Identification of Market Failure: Are Debtor Countries Ordinary Borrowers? The analogy and a few potential differences A dual-agency perspective The government,s incentives Discussion A common-agency perspective 77 77 81 86 88 92 Vl CONTENTS 6.
(10 percent of the deposit base), the credit line with private financial institutions was at the time of the agreement meant to step in only in case of a liquidity shock exceeding 30 percent of the deposit base. As Giannini (2000) points out, however, we should not expect such arrangements to be a perfect substitute for public money. First, and as we have already noted, the amounts involved are relatively limited. Second, they must remain proper credit lines. If such credit lines are secured with