The Twin Crises The Causes of Banking and strongBalancestrong-of-Payments.pdfVIP

The Twin Crises: The Causes of Banking and Balance-of-Payments Problems By GRACIELA L. KAMINSKY AND CARMEN M. REINHART* In the wake of the Mexican and Asian currency turmoil, the subject of financial crises has come to the forefront of academic and policy discussions. This paper analyzes the links between banking and currency crises. We find that: problems in the banking sector typically precede a currency crisis—the currency crisis deepens the banking crisis, activating a vicious spiral; financial liberalization often precedes banking crises. The anatomy of these episodes suggests that crises occur as the economy enters a recession, following a prolonged boom in economic activity that was fueled by credit, capital inflows, and accompanied by an overvalued currency. (JEL F30, F41) Pervasive currency turmoil, particularly in through Asia have, however, rekindled interest Latin America in the late 1970’s and early in the topic. Yet, the focus of this recent liter- 1980’s, gave impetus to a flourishing literature ature has shifted. While the earlier literature on balance-of-payments crises. As stressed in emphasized the inconsistency between fiscal Paul Krugman’s (1979) seminal paper, in this and monetary policies and the exchange-rate literature, crises occur because a country fi- commitment, the new one stresses self-fulfilling nances its fiscal deficit by printing money to the expectations and herding behavior in interna- extent that excessive credit growth leads to the tional capital markets.1 In this view, as Calvo eventual collapse of the fixed