Sovereign Liquidity Crises: Analytics and Implications for Public Policy
Bank of England Working Paper No. 121
40 Pages Posted: 19 Apr 2001
Date Written: September 2000
This paper offers an analytical framework with which to assess some recent proposals for strengthening the international financial architecture. A model is developed of sovereign liquidity crises that reflect two sources of financial stress?weak fundamentals and self-fulfilling expectations. The nature of the underlying co-ordination game is investigated, as are the properties of the unique equilibrium. In so doing, the paper characterises the welfare costs of belief-driven crises, which are found to be potentially significant. Some recent policy proposals are also evaluated, including prudent debt and liquidity management, capital controls, greater information disclosure, and the efficacy of monetary policy tightening in the midst of crisis.
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