Government Guarantees, Investment, and Vulnerability to Financial Crises

Gregor Irwin and David Vines

Review of International Economics, 2003, vol. 11, issue 5, 860-874

Abstract: The paper presents a new model of the East Asian crisis which combines three elements—moral hazard, investment collapse, and multiple equilibria—in a single account. The study locates the causes of the crisis in poor financial regulation, highly leveraged financial institutions, and implicit guarantees to the financial sector. The model has a unique long‐run equilibrium with overinvestment. But in the short run, in which the capital stock is fixed, there may be multiple equilibria. In a crisis the government is forced to renege on its guarantees; the effect is a rapid reversal of foreign capital flows.

Date: 2003
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https://doi.org/10.1046/j.1467-9396.2003.00422.x

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Working Paper: Government Guarantees, Investment And Vulnerability To Financial Crises (2000)
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