IV Financial Crises : Characteristics and Indicators of Vulnerability

second half of 1997 are the latest in a series of such episodes that have been experienced by economies in various regions of the world in recent years. In the 1990s, currency crises have occurred in Europe (the 1992–93 crises in the European Monetary System’s exchange rate mechanism, ERM), Latin America (the 1994–95 “tequila crisis”), as well as in east Asia (the 1997–98 crises in Indonesia, Korea, Malaysia, the Philippines, and Thailand). These crises have been costly in varying degrees—and particularly so where banking sector problems have been involved—both in lost output and in the fiscal and quasifiscal outlays to shore up fragile financial sectors. Also, they have involved significant international spillovers and in a number of cases have required international financial assistance to limit their severity and costs and to contain their contagious spread and spillovers to other countries. Financial crises are not unique to current financial systems, of course; history is replete with banking and exchange rate crises.77 In this century, for instance, there were the numerous financial crises of the interwar period; the sterling and French franc crises of the 1960s; the breakdown of the Bretton Woods system in the early 1970s; and the debt crisis of the 1980s. Earlier periods, too, were peppered with financial crises, especially banking crises—two notable examples were the Barings Crisis of 1890, which bears striking parallels to the Mexican crisis of 1994–95,78 and the U. S. exchange rate crisis of 1894–96, which has been seen as a speculative attack on the United States’ adherence to the gold standard and as an early example of the effectiveness of official borrowing of international reserves to stem a currency crisis.79 Indeed, it was largely in response to various crises that modern institutions and practices such as the lender-of-last-resort function of central banks, deposit insurance, prudential and regulatory standards, and international financial arrangements— especially the IMF itself—were established and evolved. Not only are financial crises not a recent phenomenon, but many of the same forces have often been at work in different crises. Financial innovations and the increased integration of global financial markets in the past two decades or so, however, do appear to have introduced some new elements and concerns, so that despite some similarities, crises in recent years have differed from those in the more distant past in important respects. In particular, the spillover effects and the contagious spread of crises seem to have become both more pronounced and far reaching. This chapter analyzes financial crises in the post–Bretton Woods period, with a view to drawing lessons about their causes, their macroeconomic characteristics, and early warning signals of vulnerability to them. The analysis considers the experience of both developing and industrial countries; for the developing countries, the focus is on emerging market economies—that is, on economies that have been significant recipients of private capital flows and thus are potentially susceptible to shifts in market sentiment.