Debt as a player in the recent

Debt as a player in the recent - inflation leads to deep...

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1. Debt as a player in the recent (past 30 years) Currency and Banking crises a. Know that crises, both banking and currency crises have been more common since liberalization of capital markets began. b. Know Mishkin’s four stages on the road to a banking and currency (twin) crisis. 1) Liberalizing under developed or poorly developed financial systems: excessive risk taking by inexperienced financial institutions, ineffective regulations by naïve officials, government guarantees can create a moral hazard, and rapid growth of credit fueled by easy access to foreign funds. 2) Run up to currency crisis: higher interest rates which led to less lending, tight credit. Companies cant get loans (even good companies). Bank failures, company failures. 3) Currency crisis: Residents and foreign speculators start to sell the currency, lenders stop lending, short term lenders pull out their money for a ‘sudden stop’. Hobson’s Choice (see ‘d’). 4) Full financial crisis: bankruptcy,
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Unformatted text preview: inflation leads to deep recession. c. Know the dangers of having a currency that is unstable. (exchange rate fluctuations and having a lender of last resort) Extremely important to have stable currency. If the domestic currency is not stable, then look to a foreign currency. Makes economy extremely vulnerable to shifts in exchange rates (if state sets a peg then borrowers are gambling that peg will endure, devaluation creates huge problem). Government can’t act as a lender of last resort. d. What is Hobson’s Choice and why is it so important for a developing country facing a currency crisis? Raised interest rates- support currency, but undermine corporate solvency and worsens the crisis. Do not raise interest rates- currency might collapse, and wipe out companies and banks with large net liabilities in foreign currency. It’s also a problem if your government is holding debt in other currencies....
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