Financial Crises, Liquidity, and the International Monetary System by Jean Tirole

Financial Crises, Liquidity, and the International Monetary System by Jean Tirole

1 Emerging Markets Crises and Policy 
Responses 
Many excellent books and articles have documented the 
new breed of "twenty-first century" financial crises. I will 
therefore content myself with a short overview of the 
main developments. This chapter can be skipped by read-

ers who are familiar with Emerging Markets (EM) crises. 
The pre-crisis period 
No two crises are identical. At best we can identify a set 
of features common to most if not all episodes. Let us 
begin with a list of frequent sources of vulnerability in 
recent capital-account crises. 
Size and nature of capital inflows. The new breed of 
crises was preceded by financial liberalization and very 
large capital inflows. In particular the removal of controls 
on capital outflows (the predominant form of capital 
control) has led to massive and rapid inflows of capital.

Instead of inducing onshore capital to flow offshore to earn 
higher returns, these removals have enhanced the appeal of 
borrowing countries to foreign investors by signaling the 
governments' willingness to keep the doors unlocked.  
At the aggregate level, the net capital flows to devel-

oping countries exceeded $240 bn in 1996 ($265 bn if 
South Korea is included), six times the number at the 
beginning of the decade, and four times the peak reached 
during the 1978-82 commercial lending boom. Capital 
inflows represented a substantial fraction of gross 
domestic product (GDP) in a number of countries: 9.4 
percent for Brazil (1992-5), 25.8 percent for Chile 
(1989-95), 9.3 percent in Korea (1991-5), 45.8 percent 
in Malaysia (1989-95), 27.1 percent in Mexico (1989-
94) and 51.5 percent in Thailand (1988-95).  
This growth in foreign investment has been accompa-

nied by a shift in its nature, a shift in lender composition, 
and a shift in recipients. Before the 1980s, medium-term 
loans issued by syndicates of commercial banks to sover-

eign states and public sector entities accounted for a 
large share of private capital flows to developing coun-

tries, and official flows to these countries were commen-

surate with private flows. 
Today private capital flows dwarf official flows. On the 
recipient side, borrowing by the public sector has shrunk 

Financial Crises, Liquidity, and the International Monetary System by Jean Tirole