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Preventing Currency Crises in Emerging Markets$
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Sebastian Edwards and Jeffrey A. Frankel

Print publication date: 2002

Print ISBN-13: 9780226184944

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226185057.001.0001

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Policy in an Economy with Balance Sheet Effects

Policy in an Economy with Balance Sheet Effects

(p.705) 15 Policy in an Economy with Balance Sheet Effects
Preventing Currency Crises in Emerging Markets
Aaron Tornell
University of Chicago Press

This chapter assesses the policy responses to crisis in the presence of enforceability problems, bailout problems, and balance sheet effects. Systemic bailout guarantees are a second-best instrument to raise investment in emerging economies. They have also investment enhancing effects in the presence of risk. Risky debt plays a useful role in promoting investment. There is a need to improve the prudential regulation concurrently with privatization and financial reforms. Bankers and regulators have incentives to believe that negative news is more transitory than it actually is and to make predictions about the banks' portfolios that are more optimistic than is warranted by the facts. The effect of this misperception is an evergreening of banks' balance sheets. It is noted that not every bailout-guarantee scheme will result in higher growth. It is important that authorities can commit to refrain from granting bailouts on an idiosyncratic basis.

Keywords:   policy, enforceability problems, bailout problems, balance sheet, systemic bailout guarantees, prudential regulation, privatization, financial reforms

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