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We extend the Tasche (2007) model on the asset correlation bias caused by a currency mismatch between assets and liabilities to the more realistic situation where some assets, and some, but not necessarily all, liabilities, are denominated in a foreign currency. To test the significance of the remaining bias we rely on a unique data base constructed by The Inter-American Development Bank (IADB) containing time-series of the asset- and liability currency composition of firms in a group of Latin American countries. Net currency mismatches are calculated and are found to vary from country to country. The correlation bias itself also varies significantly from country to country and has often been economically significant during the last 20 year-period. We find that the bias regularly is of the same magnitude as the correlation itself even in countries where the average firm has a fairly low degree of currency mismatch. Looking at market-wide corporate credit portfolios in four Latin American countries, we show that the credit risk, and associated Basel II capital charges, could increase by as much as a fifth, on average across our sample, if the actual currency mismatch in firms' balance sheets is acknowledged. In some cases the currency mismatch-induced capital charge could increase much more, sometimes to levels several times (hundreds of percent) the original capital requirement.

Recent work suggests non-financial firms have acted like financial intermediaries particularly in emerging economies. This paper corroborates these findings but then asks "why?". The results indicate evidence for carry-trade activities, but they are focused on countries with higher levels of capital controls, particular controls on inflows. There is little evidence for such activities given other potential motives. It is posited that this phenomenon is due more to the reaction of countries in the face of low global interest rates, quantitative easing and strong capital inflows than incomplete markets or the retreat of global banks due to impaired balance sheets or tighter regulations.

This thesis deals with two distinct topics, both of them representing central issues for many Central and Eastern European (CEE) countries. The first part of the thesis focuses on foreign currency (FX) lending. Several previous studies point out that in many CEE countries, FX borrowing rose significantly before the crisis and has become a major challenge for firms, households and for fiscal and monetary policy. To evaluate the risks associated with excessive FX indebtedness, we investigate firms’ willingness to match the currency composition of their assets and liabilities and their incentives to deviate from perfect matching. Our results provide strong evidence to support the role of natural hedging, however, it is not the primary motivation for firms to choose foreign currency : it explains only about 10 percent of the overall corporate FX debt during the pre-crisis and 20 percent during the post-crisis periods. Most likely, the largest part of the corporate FX debt, at least in Hungary, corresponds to open carry trade positions held by non-financial corporations. The second part of the thesis is devoted to exploring the links between tax-benefit systems and labour supply at the extensive margin. The second chapter presents an alternative modelling strategy of labour supply to the two dominating approaches based on marginal calculus and on random utility models. Finally, the last chapter uses this model to quantify the difference between the Hungarian and the Czech participation rates that can be attributed to differences in taxation and welfare benefits. We find that the estimated labour supply elasticities for the Czech Republic are very close to the results for Hungary, suggesting that, at least in this dimension, individual preferences are similar in the two countries. Results suggests that about one-half of the total difference in the participation rates can be explained by differences in the tax-benefit systems.; Cette thèse traite deux sujets distincts, les deux représentant des enjeux importants pour un grand nombre de Pays d’Europe Centrale et Orientale (PECO). La première partie porte sur les emprunts en devises étrangères. Plusieurs études antérieures montrent que dans de nombreux PECO, l’endettement en devises étrangères a augmenté de manière considérable avant la crise et est devenu un enjeu majeur pour les entreprises, les ménages et pour la politique budgétaire et monétaire. Pour évaluer les risques associés à l’endettement excessif en devises étrangères, nous étudions la volonté des entreprises d’apparier la composition en devises de leurs actifs et leurs passifs ainsi que leurs incitations à dévier de l’appariement parfait. Nos résultats fournissent des preuves solides à l’appui du rôle de la couverture naturelle. Néanmoins, ce dernier n’est pas le motif principal d’endettement en devise étrangères : le motif de couverture naturelle n’explique qu’environ 10 à 20 pour cent de la dette totale en devises étrangères des entreprises avant et pendant la crise, respectivement. La plus grande partie de la dette en devises étrangères correspondrait, au moins en Hongrie, à des positions de carry trade détenues par des sociétés non financières. La deuxième partie de la thèse est consacrée à l’exploration des liens entre les systèmes socio-fiscaux et l’offre de travail à la marge extensive. Le deuxième chapitre propose une nouvelle stratégie de modélisation de l’offre de travail comme alternative aux deux approches dominantes basées sur le calcul marginal et les modèles d’utilité aléatoire. Finalement, le dernier chapitre utilise ce modèle pour quantifier la part de la différence entre les taux d’activité tchèque et hongrois qui peut être expliquée par les divergences des systèmes d’imposition et de protection sociale. Les estimations donnent des élasticités d’offre de travail similaires, ce qui suggère que les préférences individuelles sont essentiellement identiques dans les deux pays. Nos résultats montrent que la moitié de l’écart entre les taux d’activité s’explique par les différences des systèmes socio-fiscaux.

This thesis deals with two distinct topics, both of them representing central issues for many Central and Eastern European (CEE) countries. The first part of the thesis focuses on foreign currency (FX) lending. Several previous studies point out that in many CEE countries, FX borrowing rose significantly before the crisis and has become a major challenge for firms, households and for fiscal and monetary policy. To evaluate the risks associated with excessive FX indebtedness, we investigate firms’ willingness to match the currency composition of their assets and liabilities and their incentives to deviate from perfect matching. Our results provide strong evidence to support the role of natural hedging, however, it is not the primary motivation for firms to choose foreign currency : it explains only about 10 percent of the overall corporate FX debt during the pre-crisis and 20 percent during the post-crisis periods. Most likely, the largest part of the corporate FX debt, at least in Hungary, corresponds to open carry trade positions held by non-financial corporations. The second part of the thesis is devoted to exploring the links between tax-benefit systems and labour supply at the extensive margin. The second chapter presents an alternative modelling strategy of labour supply to the two dominating approaches based on marginal calculus and on random utility models. Finally, the last chapter uses this model to quantify the difference between the Hungarian and the Czech participation rates that can be attributed to differences in taxation and welfare benefits. We find that the estimated labour supply elasticities for the Czech Republic are very close to the results for Hungary, suggesting that, at least in this dimension, individual preferences are similar in the two countries. Results suggests that about one-half of the total difference in the participation rates can be explained by differences in the tax-benefit systems.; Cette thèse traite deux sujets distincts, les deux représentant des enjeux importants pour un grand nombre de Pays d’Europe Centrale et Orientale (PECO). La première partie porte sur les emprunts en devises étrangères. Plusieurs études antérieures montrent que dans de nombreux PECO, l’endettement en devises étrangères a augmenté de manière considérable avant la crise et est devenu un enjeu majeur pour les entreprises, les ménages et pour la politique budgétaire et monétaire. Pour évaluer les risques associés à l’endettement excessif en devises étrangères, nous étudions la volonté des entreprises d’apparier la composition en devises de leurs actifs et leurs passifs ainsi que leurs incitations à dévier de l’appariement parfait. Nos résultats fournissent des preuves solides à l’appui du rôle de la couverture naturelle. Néanmoins, ce dernier n’est pas le motif principal d’endettement en devise étrangères : le motif de couverture naturelle n’explique qu’environ 10 à 20 pour cent de la dette totale en devises étrangères des entreprises avant et pendant la crise, respectivement. La plus grande partie de la dette en devises étrangères correspondrait, au moins en Hongrie, à des positions de carry trade détenues par des sociétés non financières. La deuxième partie de la thèse est consacrée à l’exploration des liens entre les systèmes socio-fiscaux et l’offre de travail à la marge extensive. Le deuxième chapitre propose une nouvelle stratégie de modélisation de l’offre de travail comme alternative aux deux approches dominantes basées sur le calcul marginal et les modèles d’utilité aléatoire. Finalement, le dernier chapitre utilise ce modèle pour quantifier la part de la différence entre les taux d’activité tchèque et hongrois qui peut être expliquée par les divergences des systèmes d’imposition et de protection sociale. Les estimations donnent des élasticités d’offre de travail similaires, ce qui suggère que les préférences individuelles sont essentiellement identiques dans les deux pays. Nos résultats montrent que la moitié de l’écart entre les taux d’activité s’explique par les différences des systèmes socio-fiscaux.

This article reviews the main issues of regulating and supervising banks in emerging markets with a view toward evaluating the long-run options. Particular attention is paid to Latin America and East Asia. These economies face a severe policy commitment problem that leads to excessive bailouts and potential devaluation of claims of foreign investors. This exacerbates moral hazard and makes a case for importing external discipline (for example, acquiring foreign short-term debt). However, external discipline may come at the cost of excessive liquidation of entrepreneurial projects. The article reviews the tradeoffs imposed by external discipline and examines various proposed arrangements, such as narrow banking, foreign banks and foreign regulation, and the potential role for an international agency or international lender of last resort. Liberalization and integration of financial markets have been associated with an increase in capital movements and with the financial crises. In particular, surges in foreign short-term debt have been blamed for crisis episodes in emerging economies in Asia (Thailand, Indonesia, and the Republic of Korea) and Latin America (Mexico, Brazil, Ecuador, and Argentina), as well as in the periphery of Europe (Turkey). These crises have proved costly in terms of output. Several policy responses have been suggested. Among them have been the reduction of short-term debt, the development of stock markets, the improved regulation and supervision of domestic financial system, enhanced transparency requirements and market discipline, and the establishment of an international lender of last resort. A catalog of “solutions” has been proposed to take care of the problems of banking in emerging market economies including moving to a narrow bank system, building a currency union, and leaving banking in the hands of foreign banks and offshore institutions. This article identifies policy responses tailored to the needs of emerging market and developing economies. The question is whether the regulatory policies and

Recent research suggests that management of the public sector debt can have important effects on a country macroeconomic performance. This Public debt management and macroeconomic stability article provides an overview of the factors that the recent literature has identified as important in determining the optimal composition of the public debt. Based on this analysis, it attempts to establish general guidelines for public debt management in emerging economies. To retain market access and promote domestic financial market development, governments should generally finance themselves at market rates using a wide variety of securities. Beyond this general principle, the optimal composition of the public debt involves a tradeoff between enhancing the government anti-inflationary credibility and reducing the vulnerability of its budget to macroeconomic shocks. Consequently, the optimal composition of the debt depends on a country circumstances. Debt should be heavily weighted toward long-term nominal securities for governments that have anti-inflationary credibility and toward long-term indexed debt for those that do not.

We analyse how short termism, dollarization and foreign jurisdictions are ways of coping with systemic risks prevalent in emerging economies. These are symptoms at least as much as problems. We conclude first that under high systemic risks, the market equilibrium settles in favour of investor protection against price risk (through short-duration peso and dollar contracts) instead of protection against default risk. Second, the option value to litigate in the event of default, which is higher in dollar and foreign-jurisdiction contracts, may explain this equilibrium outcome and, more generally, the ‘original sin’. Third, dollar contracts trump short-duration peso contracts as a risk-coping device; they are a better hedge against inflation volatility and are superior at mitigating the risk of loss given default. Fourth, according to a conservation principle, the mitigation of risk via the use of a coping mechanism allows additional risk taking in other forms, leaving total risk unchanged.

Currency mismatch makes a debtor country suffer from domestic depreciation by magnifying the burden of its external debt. Since external debt can be paid back by exporting more than importing, a crucial channel for inducing recovery is net export. It is not warranted, however, that domestic depreciation will boost net export correspondingly if the currency compositions differ substantially between debt and trade. This paper examines the association between the debt revaluation and trade competitiveness gain effects of exchange rate fluctuations for middle and low income countries. Empirical results suggest that currency-compositional discord between debt and trade has significant welfare implications.

In 2014, economic growth slowed as it began to adjust to unsustainable economic imbalances. Real GDP growth softened to 7 percent in the first 9 months, from 12.8 percent in the previous year. Despite strong mining production growth of 26 percent, the growth of the non-mining sector of the economy dropped to 2 percent in the third quarter from 17.4 percent a year ago. Investment sharply fell amidst declining FDI and weakening business prospects. Consumption remains relatively strong but is also gradually softening. The growth effect from stimulus measures of the last year is also wearing off in 2014 as large liquidity support from the central bank cannot be sustained in the wake of high inflation and external vulnerabilities. The current account deficit is narrowing significantly to around 11 percent of GDP from almost 30 percent in the previous three years, due to import contraction over 16 percent and stronger copper exports. However, a significant external financing gap continues amidst declining foreign investment, reducing internal reserves to less than three months import cover. Inflation remains in double digits after a strong credit boom in 2014 and continuous currency depreciation. Economic growth is likely to continue to soften in 2015 as the economy remains under pressure from the external imbalance and high inflation. To help achieve the goal of the new Solutions-oriented Government to overcome economic challenges and build a sound economic management system, the following policy actions are recommended to be considered in the economic policy framework: (1) Consolidate the off-budget spending made through the DBM into the budget; (2) prepare a credible and realistic fiscal consolidation plan to reduce the deficit; (3) monetary policy should be tightened; (4) further quasi-fiscal activities need to be avoided; and (5) the exchange rate should be left flexible.

Based on a theoretical model, this paper shows that foreign reserves are useful for a country to enhance the resilience of its domestic economy against balance sheet effects in the context of external financing strains. Using foreign reserves, the government can either lend in foreign currency to the private sector or conduct expenditure-switching policy to increase fiscal spending on domestic goods. Both policies cam remove the bad equilibrium represented by a large depreciation of the domestic currency and a very low level of investment. Nevertheless, these two policy tools differ in the ways they stabilize the domestic economy and in terms of the minimum required amount of foreign reserves. A targeted lending works by altering investors’ expectation on domestic exchange rate and firms’ net worth. As long as foreign reserves are sufficient to cover the private sector’s external debt, the bad equilibrium is removed even without an actual depletion of reserves. On the contrary, fiscal spending increases the demand for domestic goods and affects the relative price, leading to domestic exchange rate appreciation that increases firms’ net worth and facilitates investment.

This thesis examines issues related to the sharp surge in credit denominated in foreign currency (FX) in the New EU Member States before the advent of the recent crisis. We commence with the introduction of some stylized facts as well as decisive determinants of credit euroization, including the exchange rate regime. Subsequently, the economic performance and soaring volume of non-performing loans during the crisis are found to be adversely related to previous FX credit growth. Furthermore, we discuss some challenges, which are faced by the monetary authority of a credit euroized economy. Next, we construct a distinctive index on currency mismatch adjusted for unhedged borrowers, which appears to be significantly associated with country risk premia. The final chapter is devoted to the recent materialization of vulnerabilities connected to FX lending in Hungary. The sensitivity of this economy to exchange rate movements is illustrated by strong correlation between CDS spread and relevant exchange rates. Additionally, we scrutinize the latest version of controversial government schemes designed to mitigate the negative balance sheet effect on households indebted in FX. A unique estimation of the long-term costs of a CHF mortgage in comparison to a forint mortgage loan is provided. The impact of...

This paper investigates currency mismatch in the Hungarian corporate sector. Using a novel dataset on non-financial firms we first identify firms with mismatch, measure their weight in the economy and show their main characteristics. We then a analyze the performance of firms during the crisis. We find that a significant share of firms with FX debt had no natural hedge, i.e. no FX revenues from exports. The firms exposed to currency mismatch had a sizeable share both in real aggregates and on the loan market before the crisis. Firms with currency mismatch tended to be larger and more indebted, which suggests that FX borrowing might have eased their liquidity constraint before the crisis. During the crisis balance sheet effects were likely to be triggered by the large depreciations. Firms with FX loans had a larger fall in investment, and were more likely to go bankrupt. Their deteriorating performance and the reassessment of holding FX debt both by banks and firms led to major changes on the loan market. FX lending became less popular, and firms with mismatch were less likely to get new loans.

We review some aspects of financial dollarization in Russia, applying the main relevant theories to analyze the dynamics of several dollarization indicators. An econometric model of the short run dynamics of deposit and loan dollarization is estimated for the last decade. We find that ruble appreciation was the main driver of the de-dollarization that occurred then and of the later episode of renewed dollarization. We estimate the overall (and sector-al) currency mismatches of the Russian economy. The results show a gradual improvement of the net foreign currency position of the public sector, where we have seen significant accumulation of international reserves by the Bank of Russia and repayment of government debt. Evidence is also presented for the significant currency risk vulnerability of the nonbanking private sector. Several existing empirical studies are examined in order to assess the growth losses of the Russian economy following the crisis of 2008, which was linked with the financial dollarization.

We would like to thank Enrique Alberola, Joshua Aizenman, Erik Berglöf, Guillermo Calvo, Jin Han, Andrea Ichino, Jean Imbs, Maurizio Mazzocco, Joe Ostroy, Amine Ouazad and Romain Wacziarg as well as participants at the Economic Policy panel meeting for helpful comments, and the following people for sharing their data sets with us: Reza Baqir (IMF Vulnerability Exercise for Emerging Economies); Herman Kamil (foreign currency borrowing by sector in Latin America); Stephanie Prat (foreign currency foreign assets and liabilities for various emerging economies); and Christoph Rosenberg and Marcel Tirpak (direct borrowing in East Europe from abroad). The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy.The Managing Editor in charge of this paper was Tullio Jappelli.

Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the determinants of foreign currency (FX) lending in Emerging Europe. We find that FX lending by all banks, regardless of their ownership structure, is strongly determined by the macroeconomic environment. We find no evidence of foreign banks ‘pushing’ FX loans indiscriminately because of easier access to wholesale funding in foreign currency. In fact, while foreign banks do lend more in FX to corporate clients, they do not do so to retail clients. We also find that after a take-over by a foreign bank, the acquired bank does not increase its FX lending any faster than a bank which remains in domestic hands.

Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the determinants of foreign currency (FX) lending in Emerging Europe. We find that FX lending by all banks, regardless of their ownership structure, is strongly determined by the macroeconomic environment. We find no evidence of foreign banks ‘pushing’ FX loans indiscriminately because of easier access to wholesale funding in foreign currency. In fact, while foreign banks do lend more in FX to corporate clients, they do not do so to retail clients. We also find that after a take-over by a foreign bank, the acquired bank does not increase its FX lending any faster than a bank which remains in domestic hands.

We analyze the dual role of currency mismatch: as a vehicle that exposes the economy to systemic risk, but also as an engine of growth. We do so at the macro and the micro levels for emerging European economies in recent years. At the aggregate level, we construct a new index of currency mismatch in the banking sector that controls for lending made by banks to unhedged borrowers--i.e., those with no foreign currency income. Using our index, we find that across emerging European economies, increases in currency mismatch are associated with higher growth in tranquil times, but with a greater severity of crisis. These results are also confirmed for a broader sample of emerging economies. On net, after taking into account the crisis period, we find a positive link between currency mismatch and growth. In our firm-level analysis, we find that currency mismatch helps relax borrowing constraints and enhances firms' growth in emerging Europe. These effects are stronger across sets of financially constrained firms--those that are small and are in nontradables sectors.

Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the determinants of foreign currency (FX) lending in Emerging Europe. We find that FX lending by all banks, regardless of their ownership structure, is strongly determined by the macroeconomic environment. We find no evidence of foreign banks ‘pushing’ FX loans indiscriminately because of easier access to wholesale funding in foreign currency. In fact, while foreign banks do lend more in FX to corporate clients, they do not do so to retail clients. We also find that after a take-over by a foreign bank, the acquired bank does not increase its FX lending any faster than a bank which remains in domestic hands.

Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the determinants of foreign currency (FX) lending in Emerging Europe. We find that FX lending by all banks, regardless of their ownership structure, is strongly determined by the macroeconomic environment. We find no evidence of foreign banks ‘pushing’ FX loans indiscriminately because of easier access to wholesale funding in foreign currency. In fact, while foreign banks do lend more in FX to corporate clients, they do not do so to retail clients. We also find that after a take-over by a foreign bank, the acquired bank does not increase its FX lending any faster than a bank which remains in domestic hands.

Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the determinants of foreign currency (FX) lending in Emerging Europe. We find that FX lending by all banks, regardless of their ownership structure, is strongly determined by the macroeconomic environment. We find no evidence of foreign banks ‘pushing’ FX loans indiscriminately because of easier access to wholesale funding in foreign currency. In fact, while foreign banks do lend more in FX to corporate clients, they do not do so to retail clients. We also find that after a take-over by a foreign bank, the acquired bank does not increase its FX lending any faster than a bank which remains in domestic hands.

Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the determinants of foreign currency (FX) lending in Emerging Europe. We find that FX lending by all banks, regardless of their ownership structure, is strongly determined by the macroeconomic environment. We find no evidence of foreign banks ‘pushing’ FX loans indiscriminately because of easier access to wholesale funding in foreign currency. In fact, while foreign banks do lend more in FX to corporate clients, they do not do so to retail clients. We also find that after a take-over by a foreign bank, the acquired bank does not increase its FX lending any faster than a bank which remains in domestic hands.

Credit market imperfections give rise to boom-bust cycle episodes in emerging markets. In the present paper, we aim to provide a comprehensive analysis for Eastern Europe. We focus on documenting credit market imperfections, asymmetric financing opportunities across sectors, and business cycle fluctuations at the aggregate and sectoral level. The results will be discussed in the policy context of the re-regulation of the financial system. We will propose in an unconventional way to think about the early introduction of the Euro currency.

Despite an abundance of cross-section, panel, and event studies, there is strikingly little convincing documentation of direct positive impacts of financial opening on the economic welfare levels or growth rates of developing countries. The econometric difficulties are similar to those that bedevil the literature on trade openness and growth, though if anything, they are more severe in the context of international finance. There is also little systematic evidence that financial opening raises welfare indirectly by promoting collateral reforms of economic institutions or policies. At the same time, opening the financial account does appear to raise the frequency and severity of economic crises. Nonetheless, developing countries continue to move in the direction of further financial openness. A plausible explanation is that financial development is a concomitant of successful economic growth, and a growing financial sector in an economy open to trade cannot long be insulated from cross?border financial flows. This survey discusses the policy framework in which financial globalization is most likely to prove beneficial for developing countries. The reforms developing countries need to carry out to make their economies safe for international asset trade are the same reforms they need to carry out to curtail the power of entrenched economic interests and liberate the economy's productive potential.

This paper evaluates the potential effects of the Basel II accord on preventing the transmission from currency crises to financial crises. By analyzing the case study of South Korea, it shows how mismatches on banks’ balance sheets were the primary cause for such a transmission, and models how Basel II would have affected those balance sheets. The paper shows that due to South Korea’s positive credit rating in the months leading up to the crisis, the regulatory capital reserves under Basel II would have been even lower than those under Basel I, and that therefore Basel II would have had adverse effects on the development of the crisis. In the second part, the article analyses whether the behavior of rating agencies has changed since their failure to predict the Asian crisis. The paper finds no robust econometric evidence that rating agencies have started to take micromismatches into account when assigning sovereign ratings. Thus, given the current approach of credit rating agencies, we have reservations concerning the effectiveness of Basel II to prevent the transmission from currency crises to banking crises, both for the case of South Korea and for potential future crises. Die vorliegende Arbeit untersucht die möglichen Effekte der Basel II-Bankenregulierung auf die Transmission von Währungskrisen zu Bankenkrisen. Die Analyse des Beispiels Südkorea zeigt die wichtige Rolle der Unausgeglichenheit von Bankaktiva und -passiva in bezug auf deren Fristigkeit und Währung bei diesem Transmissionsprozess und stellt dar wie Basel II auf die Bankenbilanzen gewirkt hätte. Es wird gezeigt, dass die regulatorischen Kapitalanforderungen unter Basel II, aufgrund der guten Kreditratings im Vorfeld der Krise, geringer gewesen wären als unter Basel I. Dadurch wäre die Krise verschärft worden. Im zweiten Teil der Arbeit wird analysiert, ob die Ratingagenturen ihr Verhalten seit dem Versagen bei der Prognose der Asienkrise geändert haben. Dieser Beitrag findet keine empirische Evidenz für eine Berücksichtigung der Unausgeglichenheit in den Bankenbilanzen bei der Ableitung von Ratingergebnissen für Länder. Deshalb muss die Effektivität von Basel II bei der Prävention der Transmission von Währungs- zu Bankenkrisen sowohl im Falle Südkoreas als auch bei möglichen zukünftigen Krisen angezweifelt werden.

Mexico, a prominent liberalizer, failed to attain stellar gross domestic product (GDP) growth in the 1990s, and since 2001 its GDP and exports have stagnated. In this paper we argue that the lack of spectacular growth in Mexico cannot be blamed on either the North American Free Trade Agreement (NAFTA) or the other reforms that were implemented, but on the lack of further judicial and structural reform after 1995. In fact, the benefits of liberalization can be seen in the extraordinary growth of exports and foreign domestic investment (FDI). The key to the Mexican puzzle lies in Mexico's response to crisis: a deterioration in contract enforceability and an increase in nonperforming loans. As a result, the credit crunch in Mexico has been far deeper and far more protracted than in the typical developing country. The credit crunch has hit the nontradables sector especially hard and has generated bottlenecks, which have blocked growth in the tradables sector and have contributed to the recent fall in exports.

We address the question of whether growth and welfare can be higher in crisis prone economies. First, we show that there is a robust empirical link between per-capita GDP growth and negative skewness of credit growth across countries with active financial markets. That is, countries that have experienced occasional crises have grown on average faster than countries with smooth credit conditions. We then present a two-sector endogenous growth model in which financial crises can occur, and analyze the relationship between financial fragility and growth. The underlying credit market imperfections generate borrowing constraints, bottlenecks and low growth. We show that under certain conditions endogenous real exchange rate risk arises and firms find it optimal to take on credit risk in the form of currency mismatch. Along such a risky path average growth is higher, but self-fulfilling crises occur occasionally. Furthermore, we establish conditions under which the adoption of credit risk is welfare improving and brings the allocation nearer to the Pareto optimal level. The design of the model is motivated by several features of recent crises: credit risk in the form of foreign currency denominated debt; costly crises that generate firesales and widespread bankruptcies; and asymmetric sectorial responses, where the nontradables sector falls more than the tradables sector in the wake of crises.

The academic literature has so far little to say about the underlying causes of the large structural asset and liability imbalances of emerging markets that frequently contributed to financial crises. The aim of the paper is to contribute to filling this gap by proposing a theoretical model that links currency and maturity mismatches with real volatility in the economy. We show that if (i) a significant share of the debt is denominated in foreign currency-creating a currency mismatch- and (ii) borrowing is constrained by solvency, then currency mismatch can create and exacerbate a maturity mismatch. An important feature of the model is that higher economic or political uncertainty tightens solvency constraints and tilts the debt profile towards short term debt, thereby increasing the volatility of output. Taking the model implications to the data, we find empirical support for the model’s predictions using data for 28 emerging market economies.

The aim of this paper is to highlight the origins of the currency and maturity mismatches in the balance sheets of emerging countries. We show that short-term debt in the form of demandable debt works as a commitment device of the financial intermediary and as a form of protection of foreign lenders in a context of poor enforceability of contracts. The currency mismatch in the non-tradable sector is mainly viewed as a supply-side phenomenon. It results from the choice of foreign lenders whose anticipations of exchange rate risk overpass those of default of the banking and/or private sector following a real adverse shock. Finally, when it comes to simultaneously explain the maturity and the currency composition of debt, the paper shows that the short-term foreign currency denominated debt, with the option of early withdrawal of the demandable debt, allows investors to offset the debtor default risk if a currency depreciation occurs.

In this paper we focus on the different historical regime experiences of the core and the periphery. Before 1914 advanced countries adhered to gold while periphery countries either emulated the advanced countries or floated. Some peripheral countries were especially vulnerable to financial crises and debt default in large part because of their extensive external debt obligations denominated in core country currencies. This left them with the difficult choice of floating but restricting external borrowing or devoting considerable resources to maintaining an extra hard peg. Today while advanced countries can successfully float, emergers who are less financially mature and must borrow abroad in terms of advanced country currencies, are afraid to float for the same reason as their nineteenth century forbearers. To obtain access to foreign capital they may need a hard peg to the core country currencies. Thus the key distinction between core and periphery countries both then and now that we emphasize in this paper is financial maturity, evidenced in the ability to issue international securities denominated in domestic currency. Evidence in Section 2 from Feldstein-Horioka tests 1880-1997 agrees with the 'Folk' wisdom that financial integration was as high before 1914 as it is today. But the evidence suggests that it was not the exchange rate regime followed that mattered but the presence of capital controls. Moreover the financial integration observed for the recent period is largely an advanced country phenomenon Section 3 lays out the financial maturity hypothesis, presents narrative evidence for the pre-1914 period of the different experiences of the core and peripheral countries in adhering to the gold standard, and documents that for the emerging countries, plus ca change. Finally, Section 4 presents empirical evidence for core and peripheral countries 1880-1913 and today based on traditional money demand regressions suggesting a strong link between financial depth and the exchange rate regime.

In this Paper we focus on the different historical regime experiences of the core and the periphery. Using conventional Feldstein-Horioka tests, but taking a more careful look at the panel properties of our sample, this Paper reports results which are consistent with the ‘Folk’ wisdom that financial integration was as high before 1914 as it is today. But the evidence suggests that it was not the exchange rate regime followed that mattered for deeper integration but the presence of capital controls. Moreover, we find that the financial integration observed for the recent period is truly an advanced country phenomenon, suggesting that the causality goes from globalization to the exchange rate regime rather than the other way round. We develop this intuition by showing that before 1914, advanced countries adhered to gold while periphery countries either emulated the advanced countries or floated. Some peripheral countries were especially vulnerable to financial crises and debt default in large part because of their extensive external debt obligations denominated in core country currencies. This left them with the difficult choice of floating but restricting external borrowing or devoting considerable resources to maintaining an extra hard peg. Today while advanced countries can successfully float, emergers, who are less financially mature and must borrow abroad in terms of advanced country currencies, are afraid to float for the same reason as their 19th century forbearers. To obtain access to foreign capital they may need a hard peg to the core country currencies, or else can resort to capital controls. Thus the key distinction between the exchange rate regime of core and periphery countries both then and now that we emphasize in this Paper is financial maturity, evidenced in the ability to issue international securities denominated in domestic currency.

This paper constructs a new measure of currency mismatch in the banking sector that controls for bank lending to unhedged borrowers. This measure explicitly takes into account the indirect exchange rate risk that banks undertake when they lend to borrowers that will not be able to repay in the event of a sharp depreciation. Such systemic risk taking is not captured by indicators that are based only on banks’ balance sheet data. The new measure is constructed for 10 emerging European economies and for a broader sample that includes 19 additional emerging economies, for the period 1998 - 2008. Comparisons with previous currency mismatch measures that do not adjust for unhedged foreign currency borrowing illustrate the advantages of the new approach. In particular, the new measure flagged the indirect currency mismatch vulnerabilities that were building up in a number of emerging economies before the recent global crisis. Measuring currency mismatch more accurately can help country authorities in their efforts to address vulnerabilities at the right time, avoiding hurting growth prospects.