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 Gain for U.S. International Lending Equilibrium

Financial Crises : What Can and Does Go Wrong Waves of over-lending and over-borrowingExogenous international shocksExchange rate riskFickle international short-term lendingGlobal contagion

Fickle international short-term lending International Lender Domestic Bank Domestic Borrowers  What would happen if this lender refuse to refinance ?  What would happen if this lender increase its interest ?  What would happen if this lender refuse to refinance ?  What would happen if this lender increase its interest ?

Resolving Financial Crises 1. 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 to cushion 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 agreement among 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.