Eye of the Storm

New-style crises prompt rethink about prevention and resolution measures.

Like weather forecasters, economists are frequently blamed for getting their predictions wrong. Open the newspaper almost any day of the week, and it seems as if another financial storm is brewing somewhere in the world. Can economists predict these storms better, so that policymakers can take steps to build up their defenses and, if need be, batten down the hatches? And do these storms have to be so destructive?

This issue of Finance & Development takes a look at some initiatives of the international financial institutions, in particular the IMF, to minimize the outbreak of financial crises and resolve them more quickly and less painfully. These crises, involving various combinations of currency, banking, and debt problems (see Box 1), have thrown several emerging market economies into turmoil since the mid-1990s, from East Asia to Latin America and also including Russia and Turkey. They have been characterized by sudden large capital outflows, which have made it clear that the opportunities of globalization do not come without risks. For many developing countries, private financing now plays a far greater role than in the past, relative to official financing. Countries around the globe are increasingly interconnected through trade and financial channels. And external financing difficulties and exchange rate pressures are more strongly linked with distress in the financial and corporate sectors.

Box 1 Currency, banking, and debt crises

A foreign exchange, or currency, crisis occurs when a speculative attack on a country's currency results in a devaluation or sharp depreciation or forces the central bank to defend the currency by selling large amounts of reserves or by significantly raising interest rates. Some analysts distinguish between "old-style" or "slow motion" currency crises, and "new-style" crises. The former climax after a period of overspending and real appreciation that weaken the current account, often in a context of extensive capital controls, and end in devaluation. In the latter, investors have concerns about the creditworthiness of the balance sheet of a significant part of the economy (public or private), which, in an environment of more liberated and integrated capital and financial markets, can lead very rapidly to pressure on the exchange rate.

A banking crisis occurs when actual or potential bank runs, or failures, induce banks to suspend the internal convertibility of their liabilities or force the government to intervene to prevent this by providing banks with large-scale financial support. Banking crises tend to last longer than currency crises and have more severe effects on economic activity. Banking crises were relatively...