Altig, D, C. Carlstrom, and K. Lansing (1995), “Computable General Equilibrium Models and Monetary Policy Advice,” Journal of Money, Credit, and Banking, V. 27, No. 4 (November), pp. 1472-93.
Calomiris C. W., and G. Gorton (1991), “The Organs of Banking Panics: Models, Facts and Bank Regulation: in R.G. Hubbard (Ed.) Financial Markets and Financial Crises. Chicago, University of Chicago Press.
Diamond, D. W., and P. Dybvig (1983), “Bank Runs, Deposit Insurance, and Liquidity,” Journal of Political Economy, June, 91(3), pp. 401-19.
Diaz-Gimenez, J., E. Prescott, T. Fitzgerald, and F. Alvarez (1992) “Banking in Computable General Equilibrium Economies,” Journal of Economic Dynamics and Control, 16, No. 3/4, pp. 533-60.
Feltenstein, A. and A. Shah (1995) “General Equilibrium Effects of Investment Incentives in Mexico,” Journal of Development Economics, 46, pp. 253-69.
Feltenstein, A. (1992), “Oil Prices and Rural Migration: The Dutch Disease Goes South,” Journal of International Money and Finance, No. 11, pp. 273-91.
Feltenstein, A., and S. Morris (1990), “Fiscal Stabilization and Exchange Rate Instability: A Theoretical Approach and Some Policy Conclusions using Mexican Data,” Journal of Public Economics, August, 1990, 42, pp. 329-56.
Jarque, Carlos M., (1988), “An Empirical Study of the Determinants of Production in Mexico,” unpublished discussion paper, Secretariat of Budget and Planning, Mexico.
Labadie, P. (1995), “Financial Intermediation and Monetary Policy in a General Equilibrium Banking Model,” Journal of Money, Credit, and Banking, Vol. 27, No. 4 (November), pp. 1290-1315.
Shoven, J.B., and J. Whalley (1984), “Applied General-Equilibrium Models of Taxation and International Trade: An Introduction and Survey,” Journal of Economic Literature, Vol. 22, pp. 1007-51.
Zedillo, Ernesto (1986), “Capital flight: Some Observations on the Mexican Case,” Paper presented at the Conference on Capital Flight and Third World Debt, Institute for International Economics, Washington, D.C.
A first version of the paper was completed in the summer of 1996. Ernesto Feldman died on December 12, 1996. He contributed extensively to the preparation of the paper, which reflects many of his views and ideas. Blejer and Feltenstein wish to dedicate this paper to his memory. Andrew Feltenstein is a Professor at Virginia Polytechnic Institute, and worked on this paper while visiting the Monetary and Exchange Affairs Department.
This is the most usual kind of flight to quality. There is another, not less important flight to quality that happens when depositors, faced with increasing uncertainty, shift deposits from one bank category to another that is perceived as enjoying an implicit (or explicit) guarantee. “Flight to quality” in this sense took place in Brazil, from private to federal banks after the Real Plan was adopted, and in Paraguay, from domestic to foreign-owned banks.
Calomiris and Gorton (1991, p. 112). In what follows, “banking panics” and “deposit runs” will be used as interchangeable concepts.
Despite the fact that a run may proceed for several weeks with varying intensity.
The magnitude of the run can consequently be assessed by comparing deposit withdrawals to total deposits or to base money.
The first random withdrawal risk model was developed by Diamond and Dybvig (1983). Alonso (1996) has shown that banks can make sure that runs do not occur by designing deposit contracts appropriately. However, he shows that while in some circumstances it is profit-maximizing for the bank to avoid runs, in other conditions occasional runs could be part of optimal bank behavior.
During this period a serious banking crisis also affected Mexico; however, Mexico did not suffer significant deposit runs. The absence of deposit runs in Mexico, particularly after the emergence of the serious December 1994 crisis, can be linked to the large and unexpected peso devaluation. Depositors caught by the devaluation had already incurred an enormous capital loss. Consequently, it was useless for them to withdraw funds from the system and, in fact, it paid to remain within the banking system if the expectation (later validated by facts) was that the peso devaluation had overshot and a subsequent appreciation could follow.
Interestingly enough, the experience showed a few months later that many of the banks perceived as healthy were actually in deep trouble; consequently, a second wave of runs took place.
The loss of confidence that generated the run was related to past episodes in Argentine financial history. In particular, there was the perceived threat of a deposit freeze. This sentiment led the public to move away from all banks (even from state-owned banks that were normally perceived as enjoying an implicit deposit guarantee) and to seek refuge in currency holdings, both domestic and foreign-denominated. Deposit withdrawals only subsided after Argentina reached an agreement with the IMF in March 1995, which reestablished most of the lost credibility. However, deposit runs stopped completely only after the presidential elections held in May 1995. A comprehensive analysis of Argentina’s financial crisis can be found in Machinea (1996).
Argentina was the only country in the region to be severely affected by the Mexican crisis. Perhaps this unique impact could be associated with the currency board scheme operating in Argentina. This is, however, an issue that goes beyond the scope of this paper. The relevance for our discussion here is that the Argentine crisis provides a clear factual case for the type of shock in which we are interested.
The use of neoclassical value-added functions “sitting above” an input-output matrix is common. The reader may wish to see Shoven and Whalley (1984) for articles that use this approach. An application and detailed description of functional forms are given in Feltenstein (1986).
The interpretation of these taxes is, thus, as a profit tax and a personal income tax that is withheld at the source.
We assume that all foreign borrowing for investment is carried out by the government, so that, implicitly, the government is borrowing for the private investor but the debt thereby incurred is publicly guaranteed.
It is thus claimed that, as a proxy, a firm whose investments fall below some predetermined rate is, in practice, bankrupt.
Clearly, these percentages are arbitrary and should serve only for simplification and illustrative purposes. We could have any initial pattern of distribution of bank assets across the different sectors.
An 8 percent loss of assets would be tantamount to a total liquidation of capital. Of course, other values could be equally used for the purpose of the simulation, although 8 percent corresponds to international standard practices.
This reflects the notion that the consumer worries about the safety of his own deposits as he perceives the banks becoming progressively more insolvent.
As before, 1 denotes period i and 2 denotes period i+1.
These parameter estimates are, in turn, derived from Alberro (1989a, b), Jarque (1988), Jung (1988), and Zedillo (1986). It should be emphasized that these parameters are being used only for illustrative purposes.
In particular, we take the interest elasticity of money, c, to be equal to the value estimated in Feltenstein (1992), that is, c = −0.268, where c is given in equation (Ab) (see Appendix). It is to be stressed that more important than the initial value of c is its change and direction of this change as the economy is subject to an exogenous shock.
The ratio of 18 percent is, of course, arbitrary. We should note that our quantitative results are fairly sensitive to the choice of this ratio, since falling below the threshold results in a discontinuity. Our qualitative conclusions do not change, however, when alternative ratios are chosen.
In the real world, however, one could expect that supervisory authorities start taking preventive measures before bank capital is fully depleted. We do not consider partial defaults in this world.
The magnitude of the changes in nominal and real variables are indeed exaggerated. This is intentional in order to highlight the consequences of the shock and policy responses. It is possible, of course, to obtain more realistic numerical outcomes by calibrating the impact of the shock on the changes in c, the interest elasticity.
This policy takes place with a one-period lag in order to reflect the unexpected nature of the deposit loss. If the central bank responded at the same time as the shock, then, by definition, it would not be a shock.
Indeed, only restrictions on deposit withdrawals (like deposit freezes, forced rescheduling, or exchange of deposits for long-term bonds) would be able to prevent the bank run from occurring. Such restrictions would, however, create their own problems and essentially would adversely impact credibility and the demand for financial assets.
It could be argued, however, that the monetary/fiscal policy mix response leaves the real sector on a sounder footing for the future, which would eventually have healthy repercussions on the banking sector.