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)| false Eaton, Jonathan, and Mark Gersovitz, 1988, “ Country Risk and the Organization of International Capital Transfer,” in J.B. de Macedoand R. Findlay, eds., Debt, Growth and Stabilization. Essays in Memory of Carlos F. Diaz-Alejandro( Oxford: Basil Blackwell).
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The subject of the paper was inspired by conversations with Michael Mussa, who coined the term “monsoonal effects,” and has benefited from comments by Mario Bléjer, Eduardo Borensztein, Barry Eichengreen, Matthew Fisher, Bob Flood, Peter Isard, Olivier Jeanne, Tom Krueger, Marcus Miller, and Charles Wyplosz. The paper has also benefited from comments received at a seminar at the Federal Reserve Bank of New York and a CEPR/World Bank conference on “Financial Crises: Contagion and Market Volatility,” London, May 8-9, 1998; it is to be published in a conference volume devoted to the latter. I am grateful to Matthew Olson for research assistance. The views expressed are those of the author and do not represent those of the IMF or other official institutions.
However, overborrowing for nonproductive uses was also a large contributor to the debt crisis in many developing countries.
The crisis itself had an important monsoonal component due to German unification, however, as the high interest rates in Germany and the tendency for the deutsche mark to appreciate put pressures on the ERM parities of many European currencies. Drazen (1998) points to other spillovers among these countries, which he calls “political contagion.”
Eaton and Gersovitz (1988) show that the existence of public debt (which needs to be serviced through taxation) and of decentralized private investment decisions can lead to an equilibrium with no investment as well as the social optimum, with positive investment.
However, an easy extension is to make r* stochastic, so that the risk of a rise in world interest rates raises the probability of a crisis.
It can be argued that the model also applies to risk of default on liabilities issued in foreign currency. In practice, risks of devaluation and default are linked. Devaluation increases the domestic value of foreign currency debts and makes them more difficult to repay, provoking defaults. Conversely, a default on foreign debt (as in the debt crisis of the 1980s) leads to devaluation, as the country needs to adjust to a sharp fall in capital inflows by increasing net exports.
Implicitly, there is a market among nonresidents for these bonds that equalizes their expected return with the foreign interest rate.
It is also possible that πb > 0 would give two points of inflection to the RHS of equation (8), increasing the number of equilibria for πa. This possibility was not relevant here, given the range of numerical values assumed.
Another approach, adopted in their theoretical modeling by Sachs, Tornell, and Velasco (1996), is to consider domestic currency debt, regardless of whether it is held domestically or abroad. However, it seems clear that the Asian crisis, at least, had an important external dimension, and most external debt was in foreign currency.
Korea was strongly affected by the Southeast Asian crisis, though relatively late, while South Africa was not.