Financial Crisis and Credit Crunch as a Result of Inefficient Financial Intermediation—with Reference to the Asian Financial Crisis

Jorge Chan-Lau () and Zhaohui Chen
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Zhaohui Chen: International Monetary Fund and CEPR

International Finance from EconWPA

Abstract: This paper develops a new model of international private debt financing. It shows the possibility of discontinuity in the amount of financial intermediation when the intermediary is inefficient. The model suggests a mechanism that can generate the following sequence of events: A period of relatively low capital flow despite a steady improvement in economic fundamentals (capital inflow inertia), followed by a fast buildup of capital inflow, and ended with a large capital outflow (crisis), as observed in the recent Asian financial crisis. In addition, there exists a minimum level of economic fundamental strength that can sustain large capital inflows. If the fundamental strength is not far above this minimum level, the economy will be vulnerable to shifts in market sentiment and to even a small deterioration of fundamentals. We use comparative statics to evaluate the pros and cons of various policy responses to the crisis.

Keywords: Financial crisis; Asian crisis; credit crunch; financial intermediary; capital flow; capital inflow inertia (search for similar items in EconPapers)
JEL-codes: E44 F34 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-ifn
Date: 1998-04-21, Revised 1998-09-22
Note: Type of Document - Postscript/Acrobat PDF; prepared on IBM PC using MiKTeX 1.10; to print on HP Laser Jet; pages: 23 ; figures:2 included. Postscript version prepared using dvips5.76, pdf version prepared from postscript version with ps2pdf.
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpif:9804001

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