This paper explores the causes and consequences of international financial crises, with particular attention to the role of the International Monetary Fund (IMF) in both precipitating and resolving them. Beginning with an overview of international capital flows and their macroeconomic risks, the paper traces the history of lending crises from the 1980s debt crisis through Mexico's 1994 peso collapse and the 1997 Asian financial crisis. It analyzes how overlending, weak banking regulation, currency speculation, and contagion contributed to systemic failures. The paper also evaluates IMF policy responses — including rescue packages, capital flow management, and debt restructuring — and questions whether the IMF's structural reform agenda worsened panic rather than containing it.
Demand failures are a major economic problem — one that cannot necessarily be addressed by cutting interest rates, as once believed. Small economies, such as those known as the Asian "tigers," are not invulnerable to international speculation. They may, in fact, resist cutting their interest rates, raising them instead in an effort to keep their currencies from collapse. Failed economies financed poor investments with enormous debt, and when markets turned on their currencies — causing them to plummet — the value of foreign-denominated debt grew astronomically, causing a massive number of companies to fail. The International Monetary Fund quickly identified the source of the crises as deeply structural, requiring fundamental financial reforms. Some analysts argue that the IMF should have focused more on the panic and less on reforms. Indeed, the variable performance of Korea (which rolled over debt) and Malaysia (which imposed capital controls) after the crisis suggests that IMF standards overreached and contributed to the panic.
The intention of international borrowing and lending is the creation of important fiscal gains for the countries engaged in both lending and investing, as well as for those engaged in borrowing. Lenders and investors stand to gain portfolio diversification from international financial activities, and intertemporal trade is a benefit to borrowers. Despite these well-intentioned objectives, international lending and borrowing does not always progress in an ordered and benevolent fashion, and financial crises are known to occur again and again. Intertemporal trade refers to the manner in which current financial decisions affect the availability of financial options in the future.
The primary benefit of increasing international capital flows is that improvements to the international allocation of investment and savings can result, promoting long-term income growth for participating countries. The flip side is that macroeconomic management becomes more difficult, as is evident in a number of emerging economies. The mechanism is predominantly a faster transmission of international shocks, along with an underlying increased risk of overheating and "credit and asset price boom-and-bust cycles and abrupt reversals in capital inflows."
With a membership extending to 188 countries, the International Monetary Fund (IMF) is well positioned to promote monetary cooperation across the globe in pursuit of several goals: "secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world" ("International Monetary Fund," 2012).
The Bretton Woods system of fixed exchange rates was considered overvalued, and under the pressure of Vietnam War costs — compounded by Lyndon B. Johnson's Great Society program expenditures — the system was dissolved ("International Monetary Fund," 2012). Since 1973, IMF members have been able to float their currencies freely against another currency or a basket of currencies, participate in a currency bloc, form a monetary union, or even adopt another country's currency. The only stipulation was that currencies could not be pegged to gold ("International Monetary Fund," 2012).
By and large, outflow controls have not been shown to be robustly effective, with the possible exception of the 1998 situation in Malaysia (Magud et al., 2011). Where outflow controls have been effective, the economies have been more advanced, and it has been suggested that the strength of the interventions is largely attributable to the overall higher quality of institutions and regulatory policies in those countries.
"Debt crises, Asian contagion, and currency collapse causes"
"IMF policy recommendations, rescue packages, and debt restructuring"
"Limits of economic models and policy lessons learned"
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