Financial Crises in Emerging Markets: The Lessons from 1995

65 Pages Posted: 14 Oct 1996 Last revised: 2 Oct 2010

See all articles by Jeffrey D. Sachs

Jeffrey D. Sachs

Columbia University - Columbia Earth Institute; National Bureau of Economic Research (NBER)

Aaron Tornell

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Andrés Velasco

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Date Written: May 1996

Abstract

In this paper we examine closely the financial events following the Mexican peso devaluation to uncover new lessons about the nature of financial crises. We explore the question of why, during 1995, some emerging markets were hit by financial crises while others were not. To this end, we ask whether there are some fundamentals that help explain the variation in financial crises across countries or whether the variation just reflects contagion. We present a simple model identifying three factors that determine whether a country is more vulnerable to suffer a financial crisis: a high real exchange rate appreciation, a recent lending boom, and low reserves. We find that for a set of 20 emerging markets, differences in these fundamentals go far in explaining why during 1995 some emerging markets were hit by financial crises while others were not. We also find that alternative hypotheses that have been put forth to explain such crises often do not seem to be supported by the data, such as high current account deficits, excessive capital inflows and loose fiscal policies.

Suggested Citation

Sachs, Jeffrey D. and Tornell, Aaron and Velasco, Andrés, Financial Crises in Emerging Markets: The Lessons from 1995 (May 1996). NBER Working Paper No. w5576. Available at SSRN: https://ssrn.com/abstract=3403

Jeffrey D. Sachs (Contact Author)

Columbia University - Columbia Earth Institute ( email )

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Aaron Tornell

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Andrés Velasco

Harvard University - Harvard Kennedy School (HKS) ( email )

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National Bureau of Economic Research (NBER)

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