Per Jacobsson lecture by Governor Ortiz - Basel, 7 July 2002

Recent Emerging Market Crises - What have we learned?

I. Introduction

It is an honor to be invited to deliver this lecture in memory of Per Jacobsson, a man who dedicated his life with great success to promoting international cooperation. I find this occasion particularly meaningful because this is the second time that the head of Mexico's Central Bank has been honored with an invitation to take part in this important event. Rodrigo Gómez, Director General of Banco de México from 1952 to 1970, delivered one of the inaugural lectures under the aegis of the Foundation in 1964. His insights on the importance of economic stability for the achievement of economic development explain the impressive economic performance of the Mexican economy during his tenure at the Central Bank, and continue to be very much valid today.

Since the devaluation of the Mexican peso in December of 1994 and the ensuing financial crisis, emerging market economies have been subject to frequent crises. These crises share many features that distinguish them from those that struck emerging markets in the 1980's and early 1990's. Among these I would like to highlight the following:

i) Many of the affected economies were considered star performers by market participants and international financial institutions.

ii) Although, as it is always the case, there were some voices that warned of forthcoming problems, overall, many of these economies were considered fundamentally sound. Most of the crises, in fact, were not anticipated.

iii) The magnitude of these crises, both in terms of capital account reversals and GDP contractions, was much larger than expected.

The novel characteristics of these crises prompted an intense debate on the appropriate policy response, both domestic and external, as well as onthe reform of the international financial system.

The lecture is structured as follows. First, I will briefly describe the main analytical issues that have figured in debates on recent emerging market crises. Here, I point out that, although weak fundamentals did play a role, the main common feature of these crises is the financial panic that affected these economies. Based on this diagnosis, I stress that the combination of a strong domestic policy adjustment and a large international financial assistance package was the appropriate response to contain these crises. This section also discusses the possibility that these large packages generated moral hazard among domestic policy makers or international investors. Finally, I touch upon the possibility that in some of these crises there might have been an element of insolvency. Section 3 looks at crisis management. With this aim, the paper explores the experience from recent crises to justify that, in most cases, these were not driven by solvency considerations and that a strong and fast policy response complemented with a large international financial assistance packagewas able to restore a sense of stability to financial markets. I also emphasize the difficulty of identifying ex-ante those few instances in which default was the ultimate consequence. Afterwards, that section studies the domestic policy response. Finally, this section goes over the challenges faced by IMF programs due to the different nature of the current crises. Section 4 looks at the implications that these crises had on domestic policy management and on the design of the international financial architecture, with the aim of preventing future crises. Lastly, I conclude with some thoughts on the reform of the international financial system.