Chapter 25
On the Web: Financial Crises in Emerging Market
Economies
Dynamics of Financial Crises in Emerging Market Economies
Stage One: Initiation of Financial Crisis
Stage Two: Currency Crisis
Stage Three: Full-Fledged Financial Crisis
Case: Crisis in South Korea, 1997-1998
Financial Liberalization/Globalization Mismanaged
Perversion of the Financial Liberalization/Globalization Process: Chaebols and the South Korean
Crisis
Stock Market Decline and Failure of Firms Increase Uncertainty
Adverse Selection and Moral Hazard Problems Worsen and the Economy Contracts
Currency Crisis Ensues
Final Stage: Currency Crisis Triggers Full-Fledged Financial Crisis
Recovery Commences
Case: The Argentine Financial Crisis, 2001-2002
Severe Fiscal Imbalances
Adverse Selection and Moral Hazard Problems Worsen
Bank Panic Begins
Currency Crisis Ensues
Currency Crisis Triggers Full-Fledged Financial Crisis
Recovery Begins
Gobal Box: When an Advanced Economy is Like an Emerging Economy: The Icelandic
Financial Crisis of 2008
Preventing Emerging Market Financial Crises
Beef Up Prudential Regulation and Supervision of Banks
Encourage Disclosure and Market-Based Discipline
Limit Currency Mismatch
Sequence Financial Liberalization
Chapter 25: On the Web: Financial Crises in Emerging Market Economies 153
◼ Overview and Teaching Tips
This web chapter is for instructors who want to have a more international orientation of their courses. It
extends the analysis in Chapter 8 on financial crises to economies that are just entering the world
marketplace. The analysis is parallel to that in Chapter 8, with Figure W.1, which is similar to Figure 8.1,
outlining the dynamics of financial crises in emerging market economies. Then the chapter takes students
through two detailed applications, South Korea in 1997-1998 and Argentina in 2001-2002, to illustrate
how useful the analysis in the chapter is.
I have found that my students particularly enjoy the discussion of the crazy government policies that
promote financial crises in emerging market countries, and I spend a lot of time on this in the case on
South Korea because the perverse policies to help out the chaebols, who had enormous influence on South
Korean politics. Similarly, I spend a lot of time in the case on Argentina discussing how severe fiscal
imbalances led to policies which encouraged banks to take on government debt, which eventually was to
be their downfall.
Once the case discussions are finished, students can use the material at the end of the chapter to
debate differing policies to prevent future emerging market financial crises. They also enjoy the global
box on the Icelandic financial crisis, because it illustrates how advanced economies can find themselves in
similar circumstances to emerging market economies and be subjected to the enormous costs of financial
crises.
◼ Answers to End-of-Chapter Questions
1. Mismanagement of financial liberalization or financial globalization that leads to excessive
risk taking by financial institutions that eventually blows up and leads to a financial crisis.
2. If financial liberalization and globalization are not done properly, financial institutions have
tremendous incentives to take on risk and a lending boom ensues. When the lending boom
3. Severe fiscal imbalances can result in governments encouraging financial institutions to buy
the government debt. Then when the government is unable to repay the debt, financial
4. A rise in interest rates as a result of rising interest rates abroad increases moral hazard and
adverse selection problems, while a collapse in the stock market decreases the net worth of
154 Mishkin/Eakins • Financial Markets and Institutions, Eighth Edition
Copyright © 2015 Pearson Education, Inc.
prominent financial firms also increase uncertainty and makes asymmetric information
worse, again increasing adverse selection and moral hazard problems. All of these
contribute to financial markets seizing up and thus help promote financial crises.
5. Deterioration in bank balance sheets makes it difficult for central banks to raise interest rates
to defend the currency because if they do so it will make banks worse off. Once speculators
6. With debt contracts denominated in foreign currency, the debt burden of domestic firms
increases when there is an unanticipated decline in the value of the domestic currency. Since
7. The chaebols needed to acquire funds to expand their operations because they were unprofitable.
They thus got the South Korean government to allow them to accelerate the opening of their capital
8. They can put in place regulations to increase the amount of bank capital so banks have a
greater cushion if they suffer loan losses and also have greater incentives to pursue safer
9. Emerging market countries can adopt regulations or impose taxes that restrict businesses
from borrowing in foreign currencies. Prudential regulation and supervision of banks can
10. Emerging market countries might want to implement financial liberalization and