Chapter 26: International Lending and Financial Crises Topics in chapter 26: Private and official lending and investment Gains and losses from “well-behaved” international lending Taxes on international lending International lending to developing countries Financial crises

Types of lending and investing Private Lending and Investing Long term Direct investment Loans Portfolio investment Short term Official lending and investing (e.g. IMF or World Bank)

Intertemporal Production Possibility Curves

Well behaved lending International lending may be justified in many circumstances What do we mean by well behaved lending ? Temporary balance of payments problems Lending to finance profitable investment projects World welfare will increase (see figure 26.1)

Lending to developing countries Not always “well behaved” Often used to finance consumption and public sector financial deficits Started in the 70s and 80s when “petro dollars” had to be recycled

Developing Countries External Debt

Developing Countries External Debt

Long term debt - 1998 (billion US $) - by country

Short term debt to reserves

Currency crises and banking crises

Debt crisis of the 1980s In 1981 - 1983 the world economy suffered a steep concession In 1979, the US Federal Reserve adopted a tough anti-inflationary policy which helped push the world economy into recession by 1981 Developing countries had extensive dollar denominated debts, and there was an immediate and spectacular rise in the interest burden debtor countries had to pay

Debt crisis of the 1980s In August 1982, Mexico announced that its central bank had run out of foreign reserves and it could no longer meet payments on its $ 80 billion foreign debt Seeing that the same could happen in Argentina, Brazil and Chile, banks in the industrialised countries started to cut off new credits and demanding repayment on earlier loans

Liquidity was a problem too

The Asian Crisis in 1997 and 1998

The Russian crisis in 1998 Roubles per dollar

Crises are bad for you

Why do crises occur ? Waves of overlending and overborrowing Exogenous international shocks Exchange rate risk Fickle international short-term lending Global contagion

Global contagion Think back at the Asian crisis in 1997 and 1998 Why did it spread so much Analogy - a virus infection Did the virus spread to the air-conditioning system - infecting everybody Did one person carry it with him or her - infecting just those near him or her ?

Rescue packages - IMF

What is the problem ? ”Whatever you do, don`t call the IMF” Professor Jeffrey Sachs, Harvard University, lecture IfW, Kiel, 17. May, 1999 Makes the crisis larger than necessary ? Too harsh conditions on borrowers ? Prescribes the same medicine, regardless of the decease ? Adjustment with a human face? Modul 13

IMF - not the ideal rescue ?