Chapter

Policy in an Economy with Balance Sheet Effects

Edited by Aaron Tornell

in Preventing Currency Crises in Emerging Markets

Published by University of Chicago Press

Published in print November 2002 | ISBN: 9780226184944
Published online February 2013 | e-ISBN: 9780226185057 | DOI: http://dx.doi.org/10.7208/chicago/9780226185057.003.0016
Policy in an Economy with Balance Sheet Effects

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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

Chapter.  15296 words.  Illustrated.

Subjects: International Economics

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