Banking Chapter 13 Homework These Steps Are Important They promote Safer And Sounder Banking System Ensuring That

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Chapter 13

ANSWERS TO QUESTIONS

1. What are the two basic causes of financial crises in emerging market economies?

The two basic causes of financial crises in emerging market economies are, the

2. Why might financial liberalization and globalization lead to financial crises in emerging

market economies?

Financial liberalization and globalization in themselves do not lead to financial crises in

emerging economies. Rather, it is the mismanagement of these two processes that might lead to

financial crises. Because of financial liberalization and globalization, restrictions of financial

3. Why might severe fiscal imbalances lead to financial crises in emerging market economies?

In emerging market economies, governments usually cajole or force banks to purchase their

debts. Investors who lose confidence in the ability of the government to repay this debt, unload

4. What other factors can initiate financial crises in emerging market economies?

Other factors that can initiate financial crises in emerging market economies include, a rise in

5. What events can ignite a currency crisis?

Events that can ignite a currency crisis are deterioration of banks’ balance sheet, and severe

6. Why do currency crises make financial crises in emerging market economies even more

severe?

Currency crises make financial crises in emerging market economies even more severe

because both nonfinancial and financial firms in these countries have a massive amount of

foreign currency debt. Emerging market economies denominate many debt contracts in

7. How did the financial crises in South Korea and Argentina affect aggregate demand, short-

run aggregate supply, and output and inflation in these countries?

The decline in lending by banks, in South Korea and Argentina, due to the increase in

asymmetric information problems, led to a contraction of AD, as the AD curve shifted to the

left. The collapse of the currency led to a further contraction of AD, and real GDP fell with a

8. What can emerging market countries do to strengthen prudential regulation and supervision

of their banking systems? How might these steps help avoid future financial crises?

To strengthen prudential regulation and supervision of their banking systems, emerging

market economies need to ban commercial businesses from owning banking institutions such

that risky lending behavior can be avoided. Prudential supervisors must also have adequate

9. How can emerging market economies avoid the problems of currency mismatch?

Governments can limit currency mismatch by implementing regulations or taxes that

discourage the issuance of debt denominated in foreign currency by non-financial firms.

10. Why might emerging market economies want to implement financial liberalization and

globalization gradually rather than all at once?

Financial liberalization should be implemented gradually because there is a need to ensure

that proper institutional infrastructures such as a strong prudential regulation, and supervision

policies limiting currency mismatch and disclosure requirements are in place first, thereby

ANSWERS TO DATA ANALYSIS PROBLEMS

1. Go to the World Bank’s databank website at http://databank.worldbank.org/data/reports.

aspx?source=2&country=. Find the following annual data for South Korea (the Republic of

Korea) and Thailand, for the past 25 years: (i) GDP at current US$ prices; (ii) Net foreign

direct investment, in current US$; (iii) the current account balance, in current US$; (iv) the

average official exchange rate. Download the data into a spreadsheet, and make sure the

data align correctly with the appropriate date. Calculate annual GDP growth for each year

over the period (Hint: follow the procedure indicated in Data Analysis Problem 1 at the end

of Chapter 12). Calculate the values of net foreign direct investment and current account

balance as percentage of GDP.

2. Go to the World Bank’s databank website at http://databank.worldbank.org/data/reports.

aspx?source=2&country=. Find the following annual data for Argentina, for the past 25

years: (i) GDP at current US$ prices; (ii) the general price level; (iii) the current account

balance, in current US$; (iv) government debt in percentage of GDP; (v) the exchange rate.

Download the data into a spreadsheet, and make sure the data align correctly with the

appropriate date. Calculate annual GDP growth for each year over the period, following the

procedure used in the previous question. Calculate the value of current account balance as

percentage of GDP. Calculate the annual inflation rate in terms of annual changes in the

general price level.

a. Analyze the relationship between annual GDP growth, inflation rate, government debt,

the current account balance, and the exchange rate in the two years prior to the 2001

crisis, during the crisis, and the two years after the crisis ended. Do you find a different

pattern from the Southeast Asian crisis? To what extent are government debt, inflation,

and shifts in the exchange rate related?