Session 21

International Lending and

Financial Crises

Gain & Losses from International Lending

Japan’s wealth

Marginal Product of Capital (Japan)

Rate of Return

Gain for Japan

Rate of Return

Marginal Product of Capital (US)

U.S.’s wealth

Gainfor U.S.

International LendingEquilibrium

Financial Crises : What Can and Does Go Wrong

Waves of over-lending and over-borrowing

Exogenous international shocks

Exchange rate risk

Fickle international short-term lending

Global contagion

Fickle international short-term lending

InternationalLender

InternationalLender

DomesticBank

DomesticBorrowers

What would happen if this lender refuse to refinance ?What would happen if this lender increase its interest ?

Resolving Financial Crises1. Rescue Packages

The packages generally come from 1) the “IMF”, 2) the “World Bank” and 3) “some national government”.

Purpose of the Packages

To provide some financing for new domestic investment, and tocushion the decline in aggregate demand and domestic production.

To restore investor confidence by replenishing official reserve holding and by signaling official international support for the country and its government.

To limit contagion effects.

To require the government of the crisis country to make policy changes the should speed the end of the financial crisis.

2. Debt Restructuring

Debt rescheduling changes when payments are due, by pushing the repayments schedule into the future. The amount of debt is effectively the same, but the borrower has a longer time to pay it off.

Debt reduction lowers the amount of debt.

Note : A key issue is the process of reaching a restructuring agreementamong creditors and borrowers.

Reducing The Frequency of Financial Crises 1. Developing countries should pursue sound macroeconomic

policies to avoid creating conditions in which over-borrowing or loss of confidence in the government’ capability could lead to a crisis.

2. Countries should improve the data that they report publicly to provide sufficient detail on total debt and its component, as well as on holding of international reserves, and they should report these data promptly.

3. Developing country government should avoid short-term borrowing denominated in foreign s to currencies to avoid crises that begin when foreign lenders abruptly demand payment.

4. The government should propose the strong bank regulation and provide a better supervision.

5. The developing countries should control the capital flows. Such controls could take any of several forms, including an outright limit or prohibition, a tax that must be paid to the government equal to some portion of the borrowing, or requirement that some portion of the borrowing be placed in a deposit with the country’s central bank.