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Government fiscal imbalances in emerging economies it

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Unformatted text preview: informa9on (not knowing the quality of banks’ loan poriolios) is the source of the contagion. •  A bank panic causes a reduc9on in lending (to retain cash), which in turn increases adverse selec9on and moral hazard. 8 Six Factors to Financial Crises: 4. Increases in Uncertainty •  Possible sources of uncertainty –  Failure of financial or nonfinancial ins9tu9ons –  Stock market clash and higher vola9lity •  A drama9c increase in uncertainty makes it difficult to solve the problem of adverse selec9on. ⇒ Less lending ⇒ Contrac9on in aggregate economy 9 Six Factors to Financial Crises: 5. Increases in Interest Rates •  When interest rates increases sufficiently, good credit risks are less likely to take loans, while bad credit risks are s9ll willing to borrow. •  Increases adverse selec9on problem. •  In addi9on, higher interest rates → less cash flow → less internal funds → more reliance on external funds (asymmetric informa9on exists) •  From banks’ point of view, increased adverse selec9on and moral hazard problems ⇒ less lending 10 Six Factors to Financial Crises: 6. Government Fiscal Imbalances •  In emerging economies, it is possible that governments default. •  Demand for government bonds will fall...
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