A Krugman-Dooley-Sachs Third Generation Model of the Asian Financial Crisis

Gregor Irwin and David Vines

No 2149, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper presents a multiple-equilibrium model of the Asian financial crisis. The economy has Krugman-style over-investment caused by weak financial regulation and exacerbated by government guarantees. Following Dooley, the government only has a limited capacity or willingness to honour such guarantees. The model has a unique long-run equilibrium, with over-investment. But in the short run, in which the capital stock is fixed, it also has multiple equilibria. If lenders regard lending as low-risk, then it is. But if they regard lending as high-risk then the cost of honouring guarantees rises, making the lending high-risk and the risk premium self-justifying. We argue that this model usefully captures the ideas of panic and collapse which have been popularised in Sachs' discussions of the Asian crisis.

Keywords: Asian Economic Crisis; Financial Crisis; Multiple Equilibrium; Over-Investment (search for similar items in EconPapers)
JEL-codes: E44 F34 O16 (search for similar items in EconPapers)
Date: 1999-05
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Citations: View citations in EconPapers (15)

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