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References

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1

We thank Solange de Moraes Rego for editorial assistance, Tingyun Chen for research assistance, and Alex Chailloux, Marcos Chamon, David Hidalgo, Emilia Jurzyk, Belen Sbrancia, and Gabriel Srour for useful comments on an earlier version of this paper. All remaining errors are ours.

2

See Krugman (1979), Flood and Garber (1984), and Obstfeld (1984). Krugman (1999) provides an elegant model of the new capital account crises with a focus on the role of moral hazard. The focus on capital accounts began with Calvo et al (1993) and Schadler et al (1993).

3

See Lipschitz, Lane and Mourmouras (2002b), and Bakker and Lipschitz (2011). The notion of the equilibrium real interest rate is somewhat problematic as there are two possible characterizations: the “open-economy-capital-account equilibrium”—that is, the rate at which there would be no incentive for international arbitrage because interest differentials fully incorporate risk premiums plus exchange rate expectations—and a “notional closed-economy real equilibrium” in which real interest rates reflected real rates of return. Here we are referring initially to the latter. It should be higher than advanced country rates because of relative capital scarcity provided there is rapid convergence of total factor productivity.

4

Balassa-Samuelson effects rely on the differential in productivity gains between the traded and nontraded sectors in the EME being wider than that in advanced countries—a reasonable assumption given the rapid transfer of technology in traded goods as EMEs become a platform for manufacturing production for global or regional markets. But, given rapid growth of demand, one has merely to assume a highly elastic supply of traded goods and services coupled with a more inelastic supply of nontraded goods and services to conclude that a real appreciation is inevitable.

5

See Lipschitz (2007). The stylized table draws on the examples in Ghosh (2006).

7

For more details see IMF Occasional Paper 178 (1999).

8

The Bank of Latvia maintained a peg to the euro within a narrow band of plus/minus one percent from a central rate until Latvia adopted the euro on January 1, 2014. Thus, although a full set of monetary policy instruments was technically available, in practice the peg operated similarly to a currency board.

10

See Luengnaruemitchai and. Schadler (2007) on the effects of EU membership on risk premiums.

11

Latvia’s per capita GDP (in PPP terms) grew from 22.8 percent of the US in 2002 to 33.8 in 2007.

12

The government also issued new regulations that entered into force in the summer of 2007, including that the LTV ratio for mortgage-backed loans must not exceed 90 percent.

13

The boom in Latvia, however, was much stronger than that in the US in the 1920s, which made the fall in real GDP relatively less significant. Between 2002 and 2007, real GDP in Latvia grew by 9½ percent annually, compared with 3½ percent in the US between 1924 and 1929.

14

In many cases a liberalization of financial policies may exacerbate the credit boom; in some cases, new housing finance institutions or mechanisms push the financial sector toward lower quality loans and less scrutiny of borrowers.

16

Some attribute the lackluster performance to delays in repairing the financial sector and the consequent dearth of financial intermediation (see, for example, Ogawa et al 1998), some to an inadequate fiscal response (see Posen 1998), some to monetary conditions and a liquidity trap (see Krugman 1998), and some to low rates of return on capital following the excessive investment in the boom years before the crisis (see Ando 1998).

17

It is possible that Irish exports were overstated because of transfer pricing and the particularly favorable tax regime. Also, the substantial foreign inward investment and dividend payments abroad meant that for much of the period GDP overstated income and was far above GNP.

18

Chinese consumption was weak while saving and investment ratios where extraordinarily high. For more on the Chinese growth model see Lipschitz, Rochon, and Verdier (2011).

19

This, of course, is a very stylized model of a probable growth path. The reality of the political economy will be much more complex as export producers will no doubt lobby hard against any real appreciation as other groups, real estate developers for example, lobby strongly for easier credit conditions. Policies will move between restrictiveness and ease as the situation changes and different concerns dominate.

20

Total social financing includes funding provided by financial institutions, such as banks, security firms, and insurance companies, and by markets, including the credit market, bond market, equity market, banks’ off-balance sheet items, and other intermediary markets. To be more specific, it includes bank loans (both CNY and foreign currency loans), trust and entrust loans, bank acceptance bills, corporate bond financing, nonfinancial enterprise equity financing, and other funding sources (e.g., insurance, micro lending, industry funds). Source: JP Morgan (2013).

Conventional and Insidious Macroeconomic Balance-Sheet Crises
Author: Mr. Bas B. Bakker and Mr. Leslie Lipschitz