Government Guarantees, Investment And Vulnerability To Financial Crises.
This Paper presents a new model of the East Asian crisis that combines three elements - multiple equilibria, investment collapse, and moral hazard - in a single simple account. We locate the causes of the crisis in poor financial regulation, highly-geared financial institutions, and implicit guarant...
| Main Authors: | , |
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| Format: | Working paper |
| Language: | English |
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CEPR
2000
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| _version_ | 1826303582979227648 |
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| author | Irwin, G Vines, D |
| author_facet | Irwin, G Vines, D |
| author_sort | Irwin, G |
| collection | OXFORD |
| description | This Paper presents a new model of the East Asian crisis that combines three elements - multiple equilibria, investment collapse, and moral hazard - in a single simple account. We locate the causes of the crisis in poor financial regulation, highly-geared financial institutions, and implicit guarantees to the financial sector that create moral-hazard. The model has a unique long-run equilibrium with over-investment as a result of the guarantees. But in the short run, in which the capital stock is fixed, there may be multiple equilibria. If foreign banks regard lending as low-risk, then it is. But if they regard lending as high-risk and charge a higher interest rate, then the costs of honouring guarantees rises, making the lending high-risk and the risk premium self-justifying. A crisis occurs with a switch to this second equilibrium in which the government is forced to renege on its guarantees; the effect is a reversal of foreign capital flows. Whether multiple equilibria exist - and hence whether the economy is vulnerable to a crises - depends critically on the extent of capital accumulation and the mix between debt and equity financing. |
| first_indexed | 2024-03-07T06:04:54Z |
| format | Working paper |
| id | oxford-uuid:ed7f4155-5d96-4d63-8464-bf08c9a2bed9 |
| institution | University of Oxford |
| language | English |
| last_indexed | 2024-03-07T06:04:54Z |
| publishDate | 2000 |
| publisher | CEPR |
| record_format | dspace |
| spelling | oxford-uuid:ed7f4155-5d96-4d63-8464-bf08c9a2bed92022-03-27T11:25:29ZGovernment Guarantees, Investment And Vulnerability To Financial Crises.Working paperhttp://purl.org/coar/resource_type/c_8042uuid:ed7f4155-5d96-4d63-8464-bf08c9a2bed9EnglishDepartment of Economics - ePrintsCEPR2000Irwin, GVines, DThis Paper presents a new model of the East Asian crisis that combines three elements - multiple equilibria, investment collapse, and moral hazard - in a single simple account. We locate the causes of the crisis in poor financial regulation, highly-geared financial institutions, and implicit guarantees to the financial sector that create moral-hazard. The model has a unique long-run equilibrium with over-investment as a result of the guarantees. But in the short run, in which the capital stock is fixed, there may be multiple equilibria. If foreign banks regard lending as low-risk, then it is. But if they regard lending as high-risk and charge a higher interest rate, then the costs of honouring guarantees rises, making the lending high-risk and the risk premium self-justifying. A crisis occurs with a switch to this second equilibrium in which the government is forced to renege on its guarantees; the effect is a reversal of foreign capital flows. Whether multiple equilibria exist - and hence whether the economy is vulnerable to a crises - depends critically on the extent of capital accumulation and the mix between debt and equity financing. |
| spellingShingle | Irwin, G Vines, D Government Guarantees, Investment And Vulnerability To Financial Crises. |
| title | Government Guarantees, Investment And Vulnerability To Financial Crises. |
| title_full | Government Guarantees, Investment And Vulnerability To Financial Crises. |
| title_fullStr | Government Guarantees, Investment And Vulnerability To Financial Crises. |
| title_full_unstemmed | Government Guarantees, Investment And Vulnerability To Financial Crises. |
| title_short | Government Guarantees, Investment And Vulnerability To Financial Crises. |
| title_sort | government guarantees investment and vulnerability to financial crises |
| work_keys_str_mv | AT irwing governmentguaranteesinvestmentandvulnerabilitytofinancialcrises AT vinesd governmentguaranteesinvestmentandvulnerabilitytofinancialcrises |