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PROJECT TITLE: Financial Crises

SUBJECT: Public International Law



ROLL NO : 2013133

SEMESTER : 5th Semester

Writing a Project is one of the most significant academic challenges I have ever faced.
Though this project has been presented by me but there are many people who remained in
veil, who support and helped me to complete this project.

I am very thankful to my subject teacher Asst Prof. Prathyusha ma’am without the kind of
whom and help the completion of my project was herculean task for me She donated her
valuable time from her busy time to help me to complete the project. I thanks to all of them
who help in my completion of project

ACKNOWLEDGEMENT ............................................................................................................................. 2
Introduction :- ......................................................................................................................................... 4
Financial market causes ...................................................................................................................... 6
Currency Crises ................................................................................................................................... 9
Bank Runs and Banking Crises .......................................................................................................... 12
FINANCIAL IMPLICATIONS OF CRISES ................................................................................................... 14
Important Crises.................................................................................................................................... 17
Great Depression Crises: ................................................................................................................... 17
Effects of the crises ........................................................................................................................... 19
Mexican peso crisis ........................................................................................................................... 22
Russian Crises .................................................................................................................................... 23
Inflation........................................................................................................................................ 24
Agriculture................................................................................................................................... 25
Political fallout ............................................................................................................................ 25
BIBLIOGRAPHY ...................................................................................................................................... 27

Introduction :-
Financial Crisis hit small and large countries as well as poor and rich ones. As described by
Reinhart , “financial crises are an equal opportunity menace.” They can have domestic or
external origins, and stem from private or public sectors. They come in different shapes and
sizes, evolve over time into different forms, and can rapidly spread across borders. They
often require immediate and comprehensive policy responses, call for major changes in
financial sector and fiscal policies, and can necessitate global coordination of policies.

The widespread impact of the latest global financial crisis underlines the importance of
having a solid understanding of crises. As the latest episode has vividly showed, the
implications of financial turmoil can be substantial and greatly affect the conduct of
economic and financial policies. A thorough analysis of the consequences of and best
responses to crises has become an integral part of current policy debates as the lingering
effects of the latest crisis are still being felt around the world

Crises are, at a certain level, extreme manifestations of the interactions between the financial
sector and the real economy. As such, understanding financial crises requires an
understanding of macro financial linkages, a truly complex challenge in itself

Chapter II. Causes of the crisis

Macroeconomic causes
Low inflation and low interest rates: - The last decades were characterised by an unusually
high degree of macroeconomic stability. Steady growth was combined with low and stable
inflation in most of the advanced economies. Hence this period was called the Great
Moderation. A number of factors contributed to low inflation during the last decade. The
opening of the former communist countries to world trade implied a massive supply of low
cost labour to the world economy. In combination with rapid progress in the use of
information technology, production processes could be divided into different parts and
located in different countries, resulting in shifts in the balance of world trade.

For some companies, almost the whole world became a potential production centre and
different parts could be produced at different locations. This reduced production costs
considerably in many industries. An indirect effect of the increased flexibility of production
facilities was that the bargaining power of local trade unions weakened, holding back wage
growth in more developed countries and dampening domestic inflation pressures. Many

central banks in the developed countries have adopted inflation targeting over the last two
decades. This change in the monetary policy framework has been successful in bringing
down inflation expectations. The combination of low, and lower than expected, inflation had
the consequence that key interest rates were kept very low by historic standards

Low interest rates had several implications. Borrowing by individuals to purchase residential
housing became more affordable and house prices rose substantially in many countries.
Prices doubled or trebled in just a decade. Households in those countries also recorded a very
rapid increase in their indebtedness. The most common variable to measure debt, household
debt/disposable income, reached new highs in almost all Western countries.

Higher risk taking: The increase in demand for debt was not matched by an increase in bank
deposits. Thus banks had to find funds elsewhere. This made them increasingly dependent on
the wholesales funding markets. Other financial actors, like hedge funds, also relied heavily
on short term funding on the market whereas their investments were more long term.
Financial institutions thus built up liquidity risks on a large scale. The low interest rates made
risk adverse investors uncomfortable. Treasury bonds sometime yielded less than certain
funds guaranteed return. Therefore these investors sought higher risk in order to receive
higher return. Other investors exploited the low borrowing cost to invest in higher risk assets.
Over time the higher demand for risk reduced spreads between conventional fixed-income
assets as interest rates on risky asset fell. This was interpreted as a consequence of the more
stable macroeconomic surrounding, while in reality it was also an indirect effect of investor’s
changed behaviour on the back of low interest rates.

Leverage was also increased in order to maintain a high nominal return on capital. Hedge
funds and venture capitalist are obvious examples but banks and many ordinary companies
also increased their leverage. An indirect form of risk taking was that many companies and
financial institutions to a large extent relied on short funding and a well-functioning repo
market. Liquid markets were taken for granted. However, liquidity dried up when investors
became uncertain over the quality of assets involved in asset-backed securities and the repo
market. Several companies and financial actors came under acute financial stress when they
could not refinance themselves through their ordinary sources and banks were reluctant to
step in.

Growing imbalances: For many years a number of countries had been running large current
account deficits. This situation worsened during the 2000´s. At the same time oil exporting

countries and some emerging countries, especially China, have been running large and rising
current account surpluses. A large proportion of these current account surpluses were
invested in developed countries. The increased demand resulted in higher prices and lower
government bond yields and low returns on fixed income financial assets across all advanced

Thus, apart from all the positive effects of low inflation and low interest rates, a side effect
was a rapid accumulation of debt among households in the Western world. Moreover, the
financial system became loaded with risk although its participants were largely unaware of

Failure to address the financial cycle: Many central banks, in particular the US Federal
Reserve, considered that they should not respond to the rapid rise in credit and asset prices.
Instead they should (aggressively) drop the interest rate if asset prices fell sharply and led to
an economic downturn. This approach was based on the notion that they could not identify an
asset price bubble and if they could it would be dangerous to try to deflate it – but they could
mitigate the deflationary effects on the economy of a fall in asset prices. In countries where
central banks had this approach the responsibility to address financial cycles implicit rested
with the government and, to some extent, with supervisors. However, supervisors mainly
address issues that affect individual firms and surveying systemic risks have seldom been part
of their assignment. In the end it has not always been very clear who was responsible for the
financial cycle. In many cases the rapid credit expansion and increased leverage was left
without action.

Financial market causes

The crisis occurred in a situation with high and stable growth but also with growing
macroeconomic imbalances, low interest rates and ample liquidity. However, a well-
governed and resilient financial sector should perhaps be able to function in such an
environment, without creating the excesses seen over the past decade. It was after all not the
first time when interest rates were low and asset prices were booming. Thus it can be argued
that the crisis in many ways was a result of inherent weaknesses in the financial markets,
which allowed a large but underestimated build up of risk.

Financial innovations increased complexity: The financial markets and its institutions have
grown markedly over the past decades. In the developed world, deregulation of financial
markets since the 1970s combined with globalization has lead to the formation of large and
very complex cross-border financial institutions. Global markets have also become
increasingly integrated, with large capital flows across borders and emerging economies
gaining an increasing share of international trade. Financial innovations over recent years
have increased the complexity and scale of the network of inter-relationships between
financial institutions. These innovations were made possible by both advancements in
financial theory as well as in the technical infrastructure of the financial markets.

One example is the rapid increase in financial innovation, such as securitization and over
the-counter derivatives (OTC derivatives). They were thought to achieve high nominal
returns without any significant increase of risk. As later became evident, the risks inherent in
these new products were not fully understood by banks themselves or by the regulators and

The growth of securitization was lauded by most financial industry commentators as a means
to reduce banking system risks. The purpose of securitization is to repackage and sell assets
to investors better able to manage them. The consensus before the financial crisis was that the
originate and distribute model of banking resulted in risk being diversified and distributed
more widely across the global financial system.

System-wide risks underestimated: Developments in financial markets over the last twenty
years have in certain aspects made the financial system more vulnerable to market shocks.
Financial institutions have become increasingly more dependent on continued liquidity in
securitization and other wholesale funding markets for their financing. On their own, market
participants cannot identify or manage systemic risk.
In disrupted markets, banks’ actions are motivated by self preservation and make the
financial system as a whole less stable. Regulatory standards have largely been set on the
basis that if each financial institution remained sound, then the system overall would also be
sound. But this approach underestimated the implications for system-wide risk of innovations
in financial markets. The extension of diversification, for example through expansion in the
use of securitization markets and derivatives products, increased systemic risk by creating an
increasingly complex network of interconnections between banks and other market
participants. Because financial market participants were highly interconnected, a full

assessment of the risks of investing in or lending to a bank required
information about all of the bank’s counterparties, all of its counterparties’ counterparties and
so on. This had two important implications:

1. In stable financial markets, banks did not take fully into account the potential spill-over
effects of the failure of a counterparty on the rest of the financial system.

2. When financial markets faced broader disruption, market participants over-compensated

by, for example, ceasing to lend to creditworthy counterparties.

The first of these factors meant that market discipline was not enough on its own to ensure
that systemic risk was managed effectively. The second meant that a shock that affected one,
or a group of firms, generated heightened market uncertainty, such as retail or wholesale runs
on distressed banks.


While financial crises can take various shapes and forms, in terms of classification, broadly
two types can be distinguished. Reinhart and Rogoff (2009a) distinguish two types of crises:
those classified using strictly quantitative definitions; and those dependent largely on
qualitative and judgmental analysis. The first group mainly includes currency and suddenstop
crises and the second group contains debt and banking crises. Regardless, definitions are
strongly influenced by the theories trying to explain crises

Other crises are associated with adverse debt dynamics or banking system turmoil. A foreign
debt crisis takes place when a country cannot (or does not want to) service its foreign debt. It
can take the form of a sovereign or private (or both) debt crisis. A domestic public debt crisis
takes place when a country does not honour its domestic fiscal obligations in real terms,
either by defaulting explicitly, or by inflating or otherwise debasing its currency, or by
employing some (other) forms of financial repression. In a systemic banking crisis, actual or
potential bank runs and failures can induce banks to suspend the convertibility of their
liabilities or compel the government to intervene to prevent this by extending liquidity and
capital assistance on a large scale. Since these are not so easily measurable variables, they
lend themselves more to the use of qualitative methodologies.

A number of banking crises, for example, are associated with sudden stop episodes and
currency crises

Currency Crises
Theories on currency crises, often more precisely articulated than for other types of crises,
have evolved over time in part as the nature of such crises has changed. In particular, the
literature has evolved from a focus on the fundamental causes of currency crises, to
emphasizing the scope for multiple equilibria, and to stressing the role of financial variables,
especially changes in balance sheets, in triggering currency crises (and other types of
financial turmoil). Three generations of models are typically used to explain currency crises
that took place during the past four decades.
The first generation of models, largely motivated by the collapse in the price of gold, an
important nominal anchor before the floating of exchange rates in the 1970s, was often
applied to currency devaluations in Latin America and other developing countries (Claessens,
1991). 13 These models are from seminal papers by Krugman (1979) and Flood and Garber
(1984), and hence called “KFG” models. They show that a sudden speculative attack on a
fixed or pegged currency can result from rational behavior by investors who correctly foresee
that a government has been running excessive deficits financed with central bank credit.
Investors continue to hold the currency as long as they expect the exchange rate regime
remain intact, but they start dumping it when they anticipate that the peg is about to end. This
run leads the central bank to quickly lose its liquid assets or hard foreign currency supporting
the exchange rate. The currency then collapses

The second generation of models stresses the importance of multiple equilibrium. These
models show that doubts about whether a government is willing to maintain its exchange rate
peg could lead to multiple equilibrium and currency crises (Obstfeld and Rogoff, 1986). In
these models, self-fulfilling prophecies are possible, in which the reason investors attack the
currency is simply that they expect other investors to attack the currency. As discussed in
Flood and Marion (1997), policies prior to the attack in the first generation models can
translate into a crisis, whereas changes in policies in response to a possible attack (even if
these policies are compatible with macroeconomic fundamentals) can lead to an attack and
be the trigger of a crisis. The second generation models are in part motivated by episodes like
the European Exchange Rate Mechanism crisis, where countries like the UK came under
pressure in 1992 and ended up devaluing, even though other outcomes (that were consistent
with macroeconomic fundamentals) were possible too (see Eichengreen, Rose and Wyplosz
(1996), Frankel and Rose (1996)).
The third generation of crisis models explores how rapid deteriorations of balance sheets

associated with fluctuations in asset prices, including exchange rates, can lead to currency
crises. These models are largely motivated by the Asian crises in late 1990s.

In the case of Asian countries, macroeconomic imbalances were small before the crisis –
fiscal positions were often in surplus and current account deficits appeared to be manageable,
but vulnerabilities associated with financial and corporate sectors were large. Models show
how balance sheets mismatches in these sectors can give rise to currency crises. For example,
Chang and Velasco (2000) show how, if local banks have large debts outstanding
denominated in foreign currency, this may lead to a banking cum currency crisis.

This generation of models also considers the roles played by banks and the self-fulfilling
nature of crises.

B. Sudden Stops
Models with sudden stops make a closer association with disruptions in the supply of
external financing. These models resemble the latest generation of currency crises models in
that they also focus on balance sheet mismatches – notably currency, but also maturity – in
financial and corporate sectors. They tend to give greater weight, however, to the role of
international factors as captured, for example, by changes in international interest rates or
spreads on risky assets in causing “sudden stops” in capital flows. These models can account
for the current account reversals and the real exchange rate depreciation typically observed
during crises in emerging markets. The models explain less well the typical sharp drops in
output and total factor productivity (TFP).
In order to match data better, more recent sudden stop models introduce various frictions.
While counterintuitive, in most models, a sudden stop cum currency crisis generates an
increase in output, rather than a drop. This happens through an abrupt increase in net exports
resulting from the currency depreciation. This has led to various arguments explaining why
sudden stops in capital flows are associated with large output losses, as is often the case.
Models typically include Fisherian channels and financial accelerator mechanisms, or
frictions in labour markets, to generate an output drop during a sudden stop, without losing
the ability to account for the movements of other variables.
These types of amplification mechanisms can make small shocks cause sudden stops.
Relatively small shocks – to imported input prices, the world interest rate, or productivity –
can trigger collateral constraints on debt and working capital, especially when borrowing
levels are high relative to asset values. Fisher's style debt-deflation mechanisms can then

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cause sudden stops through a spiraling decline in asset prices and holdings of collateral assets
(Fisher, 1933). This chain of events immediately affects output and demand. Mendoza (2009)
shows how a business cycle model with collateral constraints can be consistent with the key
features of sudden stops. Korinek (2010) provides a model analyzing the adverse
implications of large movements in capital flows on real activity.
Sudden stops often take place in countries with relatively small tradable sectors and large
foreign exchange liabilities. Sudden stops have affected countries with widely disparate per
capita GDPs, levels of financial development, and exchange rate regimes, as well as
countries with different levels of reserve coverage. There are though two elements most
episodes share, as Calvo, Izquierdo and Mejía (2008) document: a small supply of tradable
goods relative to domestic absorption – a proxy for potential changes in the real exchange
rate – and a domestic banking system with large foreign–exchange denominated liabilities,
raising the probability of a “perverse” cycle.
Empirical studies find that many sudden stops have been associated with global shocks. For a
number of emerging markets, e.g., those in Latin America and Asia in the 1990s and in
Central and Eastern Europe in the 2000s, following a period of large capital inflows, a sharp
retrenchment or reversal of capital flows occurred, triggered by global shocks such as
increases in interest rates or changes in commodity prices. Sudden stops are more likely
with large cross-border financial linkages. Milesi-Ferretti and Tille (2011) document that
rapid changes in capital flows were important triggers of local crises during the recent crisis.
Other papers, e.g., Rose and Spiegel (2011), however, find little role for international factors,
including capital flows, in the spread of the recent crisis.
C. Foreign and Domestic Debt Crises
Theories on foreign debt crises and default are closely linked to those explaining sovereign
lending. Absent “gun-boat” diplomacy, lenders cannot seize collateral from another country,
or at least from a sovereign, when it refuses to honor its debt obligations. Without an
enforcement mechanism, i.e., the analogue to domestic bankruptcy, economic reasons,
instead of legal arguments, are needed to explain why international (sovereign) lending exists
at all.

D. Banking Crises
Banking crises are quite common, but perhaps the least understood type of crises. Banks are
inherently fragile, making them subject to runs by depositors. Moreover, problems of
individual banks can quickly spread to the whole banking system. While public safety nets –

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including deposit insurance – can limit this risk, public support comes with distortions that
can actually increase the likelihood of a crisis. Institutional weaknesses can also elevate the
risk of a crisis. For example, banks heavily depend on the information, legal and judicial
environments to make prudent investment decisions and collect on their loans. With
institutional weaknesses, risks can be higher. While banking crises have occurred over
centuries and exhibited some common patterns, their timing remains empirically hard to pin

Bank Runs and Banking Crises

Financial institutions are inherently fragile entities, giving rise to many possible coordination
problems. Because of their roles in maturity transformation and liquidity creation, financial
institutions operate with highly leveraged balance sheets. Hence, banking, and other similar
forms of financial intermediation, can be precarious undertakings. Fragility makes
coordination, or lack thereof, a major challenge in financial markets. Coordination problems
arise when investors and/or institutions take actions – like withdrawing liquidity or capital –
merely out of fear that others also take similar actions. Given this fragility, a crisis can easily
take place, where large amounts of liquidity or capital are withdrawn because of a self
fulfilling belief – it happens because investors fear it will happen. Small shocks, whether real
or financial, can translate into turmoil in markets and even a financial crisis.

A simple example of a coordination problem is a bank run. It is a truism that banks borrow
short and lend long. This maturity transformation reflects preferences of consumers and
borrowers. However, it makes banks vulnerable to sudden demands for liquidity, i.e., “runs”
(the seminal reference here is Diamond and Dybvig, 1983). A run occurs when a large
number of customers withdraw their deposits because they believe the bank is, or might
become, insolvent. As a bank run proceeds, it generates its own momentum, leading to a self
fulfilling prophecy (or perverse feedback loop): as more people withdraw their deposits, the
likelihood of default increases, and this encourages further withdrawals. This can destabilize
the bank to the point where it faces bankruptcy as it cannot liquidate assets fast enough to
cover its short-term liabilities

Balance-of-payments crises and other parallel episodes can similarly be identified using
capital flows data. Although there are some differences in approaches (e.g., how reserves
losses are treated) and statistical variations across studies (e.g., whether the same current
account deficit threshold is used for all countries or whether country-specific variables

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thresholds are used), but many of them point to similar samples of actual events. Forbes and
Warnock (2012) analyze for a large set of countries gross flows, instead of the more typical
net capital flows (or current account). They identify episodes of extreme capital flow
movements using quarterly data, differentiating activity by foreigners and domestics. They
classify episodes as “surge”, “stop”, “flight,” or “retrenchment, with surges and stops related
respectively to periods of large gross capital in- or outflows by foreigners, and flights and
retrenchments respectively related to periods of large capital out- or inflows by domestic

External sovereign debt crises are generally easy to identify as well, although there remain
differences in classifications across studies. Sovereign defaults are relatively easy to identify
since they involve a unique event, the default on payments. Typical dating of such episodes
relies on the classification of rating agencies or on information from international financial
institutions (see McFadden, Eckaus, Feder, and Hajivassiliou (1984); and papers summarized
in Sturzenegger and Zettelmeier (2007)). Still, there are choices in terms of methodology. For
example differences arise from considering the magnitude of defaults (whether default has to
be widespread or on just one class of claims), default by type of claims (such as bank claims
or bond claims, private or public claims), and the length of default (missing a single or
several payments). Others look instead at the increases in spreads in sovereign bonds as an
indicator of (the probability of) default (Edwards, 1984).
The end of a default is harder to date though. A major issue with dating, including of default
and sovereign debt crises, can be identifying their end, i.e., when default is over. Some
studies date this as when countries regained access in some form to private financial markets.
Others use as a criteria when countries regain a certain credit rating (IMF, 2005 and 2011).
Differences consequently arise as to how long it takes for a country to emerge after a
sovereign default.

Banking crises can be particularly challenging to date as to when they start and especially
when they end. Such crises have usually been dated by researchers using a qualitative
approach on the basis of a combination of events – such as forced closures, mergers, or
government takeover of many financial institutions, runs on several banks, or the extension
of government assistance to one or more financial institutions. In addition, in-depth
assessments of financial conditions have been used as a criterion. Another metric used has
been the fiscal costs associated with resolving these episodes. The end of a banking crisis is
also difficult to identify, in part since its effects can linger on for some time.

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There are large overlaps in the dating of banking crises across different studies. Reinhart and
Rogoff (2009a) date the beginning of banking crises by two types of events: bank runs that
lead to closure of, merging or takeover by the public sector of one or more financial
institutions. If there are no runs, they check the closure, merging, takeover, or large-scale
public assistance of an important financial institution. As they acknowledge, this approach
has some obvious drawbacks: it could date crises too late (or too early) and gives no
information about the end date of these episodes

Lastly, asset price and credit booms, busts and crunches, common to many crises, are
relatively easy to classify, but again specific approaches vary across studies. Asset prices
(notably equity and to a lesser degree house prices) and credit volumes are available from
standard data sources. Large changes (in nominal or real terms) in these variables can thus
easily be identified. Still, since approaches and focus vary, so do the classifications of booms,
busts, and crunches


Macroeconomic and financial consequences of crises are typically severe and share many
commonalities across various types. While there are obviously differences between crises,
there are many similarities in terms of the patterns macroeconomic variables follow during
these episodes. Large output losses are common to many crises and other macroeconomic
variables (consumption, investment and industrial production) typically register significant
declines. And financial variables like asset prices and credit usually follow qualitatively
similar patterns across crises, albeit with variations in terms of duration and severity.

A. Real Effects of Crises

Financial crises have large economic costs. Crises have large effects on economic activity
and can trigger recessions (Claessens, Kose, and Terrones, 2009 and 2012). There are indeed
many recessions associated with financial crises (Figure 6). And financial crises often tend to
make these recessions worse than a “normal” business cycle recession (Figure 7). The
average duration of a recession associated with a financial crisis is some six quarters, two
more than a normal recession. There is also typically a larger output decline in recessions
associated with crises than in other recessions. And the cumulative loss of a recession
associated with a crisis (computed using the lost output relative to the pre-crisis peak) is also
much larger than that of a recession without a crisis.

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The real impact of a crisis on output can be computed using various approaches. For a large
cross-section of countries and long time period, Claessens, Kose and Terrones (2012) use the
traditional business cycles methodology to identify recessions. They show that recessions
associated with credit crunches and housing busts tend to be more costly than those
associated with equity price busts. Overall losses can also be estimated by adding up the
differences between trend growth and actual growth for a number of years following the
crisis or until the time when annual output growth returned to its trend. On this basis, Laeven
and Valencia (2012) estimate that the cumulative cost of banking crises is on average about
23 percent of GDP during the first four years.

Regardless of the methodology, losses do vary across countries. While overall losses tend to
be larger in emerging markets, the large losses in recent crises in advanced countries (e.g.,
both Iceland and Ireland’s output losses exceed 100 percent) paint a different picture. The
median output loss for advanced countries is now about 33 percent which exceeds that of
emerging markets, 26 percent.
Crises are generally associated with significant declines in a wide range of macroeconomic
aggregates. Recessions following crises exhibit much larger declines in consumption,
investment, industrial production, employment, exports and imports, compared to those
recessions without crises. For example, the decline in consumption during recessions
associated with financial crises is typically seven to ten times larger than those without such
crises in emerging markets. In recessions without crises, the growth rate of consumption
slows down but does not fall below zero. In contrast, consumption tends to contracts during
recessions associated with financial crises, another indication of the significant toll that crises
have on overall welfare.
There are also large declines in global output during financial crises episodes. The significant
cost for the world economy associated with the Great Depression has been documented in
many studies.

The global financial crisis was associated with the worst recession since World War II, as it
saw a 2 percent decline in world per capita GDP. In addition to 2009, there were two other

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years after WWII the world economy experienced a global recession and witnessed crises in
multiple countries1.

In 1982, a global recession was associated with a host of problems in advanced countries, as
well as the Latin American debt crisis2.

The global recession in 1991 also coincided with financial crises in many parts of the world,
including difficulties in US credit markets, banking and currency crises in Europe, and the
burst of the asset price bubble in Japan. While the world per capita GDP grows by about 2
percent in a typical year, it declined by about 0.8 percent in 1982 and 0.2 percent in 1991

B. Financial Effects of Crises

Crises are associated with large downward corrections in financial variables. A large research
program has analyzed the evolution of financial variables around crises. Some of the studies
in this literature focus on crises episodes using the dates identified in other work, others
consider the behaviour of the financial variables during periods of disruptions, including
credit crunches, house and equity price busts. Although results differ across the types of
crises, both credit and asset prices tend to decline or grow at much lower rates during crises
and disruptions than they do during tranquil periods, confirming the boom-bust cycles in
these variables discussed in previous sections. In a large sample of advanced countries
(Figure 8), credit declines by about 7 percent, house prices fall by about 12 percent and
equity prices drop by more than 15 percent during credit crunches, house and equity price
busts, respectively (Claessens, Kose and Terrones, 2011). Asset prices (exchange rates,
equity and house prices) and credit around crises exhibit qualitatively similar properties in
terms of their temporal evolution in advanced and emerging market countries, but the
duration and amplitude of declines tend to be larger for the latter than for the former .

The most notable drag on the real economy from a financial crisis is the lack of credit from
banks and other financial institutions. Dell’Ariccia, Detragiache, Rajan (2005) and
Klingebiel, Laeven and Kroszner (2007) show how after banking crises, sectors grow slower
that naturally need more external financing, likely because banks are impaired in their
lending capacity. Recoveries in aggregate output and its components following recessions

Kose, Loungani and Terrones, 2013
Mexico’s default in August 1982 marked the beginning of the crisis and the region’s decade long
stagnation (i.e., the lost decade). A number of Latin American countries, including Argentina, Mexico
and Venezuela in 1982, and Brazil and Chile in 1983, experienced debt crises during the period.

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associated with credit crunches tend to take place before the revival of credit growth and
turnaround in house prices (Figure 9). These temporal patterns are similar to those in the case
of house price busts, i.e., economic recoveries start before house prices bottom out during
recessions coinciding with sharp drops in house prices.

Both advanced and emerging market countries have experienced the phenomenon of
"creditless recoveries". Creditless recoveries are quite common to financial crises associated
with sudden-stops in many emerging market economies. Creditless recoveries are, as
expected, more common after banking crises and credit booms. The average GDP growth
during these episodes is about a third lower than during “normal” recoveries.26 Furthermore,
sectors more dependent on external finance grow relatively less and more financially
dependent activities (such as investment) are curtailed more (see also Kannan (2009)).

Micro evidence for individual countries also shows that financial crises are associated with
reductions in investment, R&D and employment, and firms passing up on growth
opportunities 3Collectively, this suggests that the supply of credit following a financial crisis
can constrain economic growth.

Important Crises :

Important crises of the era are as follow:-

1. Great Depression Crisis

2. Mexican Crisis
3. Asian Crisis
4. Russian Crisis

Great Depression Crises: - The Great Depression was a severe worldwide economic
depression in the 1930s. The timing of the Great Depression varied across nations; however,
in most countries it started in 1929 and lasted until the late 1930s. It was the longest, deepest,
and most widespread depression of the 20th century.

Worldwide GDP fell by 15% from 1929 to 1932. In the 21st century, the Great Depression is
commonly used as an example of how far the world's economy can decline.

(Campello, Graham, and Harvey, 2010 review evidence for the U.S.).

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The depression originated in the United States stock prices that began around September 4,
1929, and became worldwide news with the stock market crash of October 29, 1929 (known
as Black Tuesday).

The Great Depression had devastating effects in countries of rich and poor people.

Personal income tax revenue, profits and prices dropped, while international trade plunged by
more than 50%. Unemployment in the U.S. rose to 25%, and in some countries rose as high
as 33%.

Countries and Cities all around the world were hit hard, especially which were dependent
on heavy industry. Construction was virtually halted in many countries.

Farming communities and rural areas suffered as crop prices fell by approximately 60%.
Facing plummeting demand with few alternate sources of jobs, areas dependent on primary
sector industries such as mining and logging suffered the most.

Some economies started to recover by the mid-1930s. In many countries, the negative effects
of the Great Depression lasted until the beginning of World War II.

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Causes of Great Depression :-

The two classical competing theories of the Great Depression are :

Keynesian (demand driven) and the monetarist explanation. There are also various heterodox
theories that downplay or reject the explanations of the Keynesians and monetarists.
The consensus among demand-driven theories is that a large-scale loss of confidence led to a
sudden reduction in consumption and investment spending. Once panic and deflation set in,
many people believed they could avoid further losses by keeping clear of the markets.
Holding money became profitable as prices dropped lower and a given amount of money
bought ever more goods, exacerbating the drop in demand.
Whereas Monetarists believe that the Great Depression started as an ordinary recession, but
the shrinking of the money supply greatly exacerbated the economic situation, causing a
recession to descend into the Great Depression.

Effects of the crises :-

The majority of countries set up relief programs, and most underwent some sort of political
upheaval, pushing them to the right.
Many of the countries in Europe and Latin America that had democracy saw it overthrown
by some form of dictatorship or authoritarian rule, especially in Germany in the year 1933.

Australia: - Australia’s dependence on agricultural and industrial exports meant it was one
of the hardest-hit developed countries. Falling export demand and commodity prices placed
massive downward pressures on wages. Unemployment reached a record high of 29% in
1932 with incidents of civil unrest becoming common. After 1932, an increase in wool and
meat prices led to a gradual recovery.

France :- The crisis affected France a bit later than other countries, hitting around 1931.
While the 1920s grew at the very strong rate of 4.43% per year, the 1930s rate fell to only
0.63%. The depression was relatively mild: unemployment peaked under 5%, the fall in
production was at most 20% below the 1929 output; there was no banking crisis.

However, the depression had drastic effects on the local economy, and partly explains
the February6, 1934 riot sand even more the formation of the popular front , led by SFIO
socialist leader Léon Blum, which won the elections in 1936.

France's relatively high degree of self-sufficiency meant the damage was considerably less
than in nations like Germany. Hardship and unemployment were high enough to lead

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to rioting and the rise of the socialist Popular Front. Ultra-nationalist groups also saw
increased popularity, although democracy prevailed into World War II.


The Great Depression hit Germany hard. The impact of the Wall Street Crash forced
American banks to end the new loans that had been funding the repayments under the Dawes
Plan and the Young Plan. In 1932, 90% of German reparation payments were cancelled. (In
the 1950s, Germany repaid all its missed reparations debts.) Widespread unemployment
reached 25% as every sector was hurt. The government did not increase government spending
to deal with Germany's growing crisis, as they were afraid that a high-spending policy could
lead to a return of the hyperinflation that had affected Germany in 1923. Germany's Weimar
Republic was hit hard by the depression, as American loans to help rebuild the German
economy now stopped. The unemployment rate reached nearly 30% in 1932, bolstering
support for the Nazi (NSDAP) and Communist (KPD) parties, causing the collapse of the
politically centrist Social Democratic Party. Hitler ran for the Presidency in 1932, and while
he lost to the incumbent Hindenburg in the election, it marked a point during which both Nazi
Party and the Communist parties rose in the years following the crash to altogether possess a
Reichstag majority following the general election in July 1932.

Hitler followed an autarky economic policy, creating a network of client states and economic
allies in central Europe and Latin America. By cutting wages and taking control of labor
unions, plus public works spending, unemployment fell significantly by 1935. Large scale
military spending played a major role in the recovery.

Latin America: - Because of high levels of U.S. investment in Latin American economies,
they were severely damaged by the Depression. Within the region, Chile, Bolivia and Peru
were particularly badly affected. Before the 1929 crisis, links between the world economy
and Latin American economies had been established through American and British
investment in Latin American exports to the world. As a result, Latin Americans export
industries felt the depression quickly. World prices for commodities such as wheat, coffee
and copper plunged. Exports from all of Latin America to the US fell in value from $1.2
billion in 1929 to $335 million in 1933, rising to $660 million in 1940.

But on the other hand, the depression led the area governments to develop new local
industries and expand consumption and production. Following the example of the New Deal,

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governments in the area approved regulations and created or improved welfare institutions
that helped millions of new industrial workers to achieve a better standard of living.

Asian Crises :- The Asian financial crisis was a period of financial crisis that gripped
much of East Asia beginning in July 1997 and raised fears of a worldwide economic
meltdown due to financial contagion.

The crisis started in Thailand well known in Thailand as the Tom Yum Goong crisis with the
financial collapse of the Thai baht after the Thai government was forced to float the baht due
to lack of foreign currency to support its fixed exchange rate, cutting its peg to the U.S dollar,
after exhaustive efforts to support it in the face of a severe financial over-extension that was
in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that
made the country effectively bankrupt even before the collapse of its currency. As the crisis
spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets
and other asset prices, and a precipitous rise in private debt.

Indonesia, South Korea and Thailand were the countries that were most affected by the
crisis. Hong Kong ,Laos, Malaysia and the Philippines were also hurt by the slump. Brunei
,China , Singapore, Taiwan and Vietnam were less affected, although all suffered from a loss
of demand and confidence throughout the region.

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Foreign debt-to-GDP ratios rose from 100% to 167% in the four large Association of
Southeast Asian Nations (ASEAN) economies in 1993–96, then shot up beyond 180% during
the worst of the crisis. In South Korea, the ratios rose from 13 to 21% and then as high as
40%, while the other northern newly industrialized countries fared much better. Only in
Thailand and South Korea did debt service-to-exports ratios rise.

Although most of the governments of Asia had seemingly sound fiscal policies ,
the International Monetary Fund (IMF) stepped in to initiate a $40 billion program to
stabilize the currencies of South Korea, Thailand, and Indonesia, economies particularly hard
hit by the crisis. The efforts to stem a global economic crisis did little to stabilize the
domestic situation in Indonesia, however. After 30 years in power, President Suharto was
forced to step down on 21 May 1998 in the wake of widespread rioting that followed sharp
price increases caused by a drastic devaluation of the rupiah. The effects of the crisis lingered
through 1998. In 1998 the Philippines growth dropped to virtually zero. Only Singapore and
Taiwan proved relatively insulated from the shock, but both suffered serious hits in passing,
the former more so due to its size and geographical location between Malaysia and Indonesia.
By 1999, however, analysts saw signs that the economies of Asia were beginning to
recover. After the 1997 Asian Financial Crisis, economies in the region are working toward
financial stability on financial supervision.

Until 1999, Asia attracted almost half of the total capital inflow into developing countries
The economies of Southeast Asia in particular maintained high interest rates attractive to
foreign investors looking for a high rate of return. As a result, the region's economies
received a large inflow of money and experienced a dramatic run-up in asset prices. At the
same time, the regional economies of Thailand, Malaysia, Indonesia, Singapore, and South
Korea experienced high growth rates, 8–12% GDP, in the late 1980s and early 1993. This
achievement was widely acclaimed by financial institutions including IMF and World Bank,
and was known as part of the "Asian economic miracle”.

Mexican peso crisis :-

The Mexican peso crisis (also known as the Tequila crisis or December mistake crisis)
was a currency crisis sparked by the Mexican government's sudden devaluation of
the peso against the U.S. dollar in December 1994, which became one of the first
international financial crises ignited by capital flight. During the 1994 presidential election,
the incumbent administration embarked on expansionary fiscal and monetary policy.

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The Mexican treasury began issuing short-term debt instruments denominated in domestic
currency with a guaranteed repayment in U.S. dollars, attracting foreign investors. Mexico
enjoyed investor confidence and new access to international capital following its signing of
the North American Free Trade Agreement(NAFTA). However, a violent uprising in the state
of Chiapas, as well as the assassination of the presidential candidate Luis Donaldo Colosio,
resulted in political instability, causing investors to place an increased risk premium on
Mexican assets.

In response, the Mexican central bank intervened in the foreign exchange markets to maintain
the Mexican peso's peg to the U.S. dollar by issuing dollar-denominated public debt to buy
pesos. The peso's strength caused demand for imports to increase, resulting in a trade
deficit. Speculators recognized an overvalued peso and capital began flowing out of Mexico
to the United States, increasing downward market pressure on the peso. Under election
pressures, Mexico purchased its own treasury securities to maintain its money supply and
lavert rising interest rates, drawing down the bank's dollar reserves. Supporting the money
supply by buying more dollar-denominated debt while simultaneously honoring such debt
depleted the bank's reserves by the end of 1994.

The central bank devalued the peso on December 20, 1994, and foreign investors' fear led to
an even higher risk premium. To discourage the resulting capital flight, the bank raised
interest rates, but higher costs of borrowing merely hurt economic growth. Unable to sell new
issues of public debt or efficiently purchase dollars with devalued pesos, Mexico faced
a default. Two days later, the bank allowed the peso to float freely, after which it continued to
depreciate. The Mexican economy experienced hyperinflation of around 52% and mutual
funds began liquidating Mexican assets as well as emerging market assets in general. The
effects spread to economies in Asia and the rest of Latin America. The United States
organized a $50 billion bailout for Mexico in January 1995, administered by the IMF with the
support of the G7 and Bank for International Settlements. In the aftermath of the crisis,
several of Mexico's banks collapsed amidst widespread mortgage defaults. The Mexican
economy experienced a severe recession and poverty and unemployment increased

Russian Crises :- On 17 August 1998, the Russian government devalued the ruble,
defaulted on domestic debt, and declared a moratorium on payment to foreign creditors.[5] On
that day the Russian government and the Central Bank of Russia issued a "Joint Statement"
announcing, in essence, that;

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1. the ruble/dollar trading band would expand from 5.3–7.1 RUR/USD to 6.0–9.5
2. Russia's ruble-denominated debt would be restructured in a manner to be announced
at a later date; and, to prevent mass Russian bank default,
3. a temporary 90-day moratorium would be imposed on the payment of some bank
obligations, including certain debts and forward currency contracts.[

On 17 August 1998 the government declared that certain state securities (GKOs and OFZs)
would be transformed into new securities.

At the same time, in addition to widening the currency band, authorities also announced that
they intended to allow the RUR/USD rate to move more freely within the wider band.

At the time, the Moscow Interbank Currency Exchange (or "MICEX") set a daily "official"
exchange rate through a series of interactive auctions based on written bids submitted by
buyers and sellers. When the buy and sell prices matched, this "fixed" or "settled" the official
MICEX exchange rate, which would then be published by Reuters. The MICEX rate was
(and is) commonly used by banks and currency dealers worldwide as the reference exchange
rate for transactions involving the Russian ruble and foreign currencies.

From 17 to 25 August 1998, the ruble steadily depreciated on the MICEX, moving from 6.43
to 7.86 RUR/USD. On 26 August 1998, the Central Bank terminated ruble-dollar trading on
the MICEX, and the MICEX did not fix a ruble-dollar rate that day.

On 2 September 1998 the Central Bank of the Russian Federation decided to abandon the
"floating peg" policy and float the ruble freely. By 21 September 1998 the exchange rate had
reached 21 rubles for one US dollar, meaning it had lost two thirds of its value of less than a
month earlier.

On 28 September 1998 Boris Fyodorov was discharged from the position of the Head of the
State Tax Service.

The moratorium imposed by the Joint Statement expired on 15 November 1998, and the
Russian government and Central Bank did not renew it.


Russian inflation in 1998 reached 84 percent and welfare costs grew considerably. Many
banks, including Inkombank,Oneximbank and Tokobank, were closed down as a result of the

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The main effect of the crisis on Russian agricultural policy has been a dramatic drop in
federal subsidies to the sector, about 80 percent in real terms compared with 1997, though
subsidies from regional budgets fell less.

Political fallout

The financial collapse resulted in a political crisis as Yeltsin, with his domestic support
evaporating, had to contend with an emboldened opposition in the parliament. A week later,
on 23 August 1998, Yeltsin fired Kiriyenko and declared his intention of returning
Chernomyrdin to office as the country slipped deeper into economic turmoil.[9] Powerful
business interests, fearing another round of reforms that might cause leading enterprises to
fail, welcomed Kiriyenko's fall, as did the Communists

Yeltsin, who began to lose his hold on power as his health deteriorated, wanted
Chernomyrdin back, but the legislature refused to give its approval. After the Duma rejected
Chernomyrdin's candidacy twice, Yeltsin, his power clearly on the wane, backed down.
Instead, he nominated Foreign Minister Yevgeny Primakov, who on 11 September 1998 was
approved by the State Duma by an overwhelming majority.

Primakov's appointment restored political stability, because he was seen as a compromise

candidate able to heal the rifts between Russia's quarreling interest groups. There was popular
enthusiasm for Primakov as well. Primakov promised to make the payment of wages and
pensions his government’s first priority, and invited members of the leading parliamentary
factions into his Cabinet.

Communists and the Federation of Independent Trade Unions of Russia staged a nationwide
strike on 7 October 1998 and called on President Yeltsin to resign. On 9 October 1998,
Russia, which was also suffering from a poor harvest, appealed for international humanitarian
aid, including food.

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Official exchange rates RUB/USD and RUB/EUR set by the Bank of Russia

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1. The International Law of the Sea; Donald R. Rothwell and Tim Stephens, (Portland,
Hart publishing ltd, 2010)
2. Dr. S.K. Kapoor, International Law and Human Right, nineteenth edition (2014)
3. J.G. Stark, Introduction to International Law, eighth edition (1977)
4. Ian Brownlie, Basic documents in International Law, (8th ed. Oxford University press,
5. M.P. Tondon& Dr. V.K. Anand, International Law & Human Right, (16th ed.,
Allahabad Law Agency, 2005)
Articles & pdf
1. Tamsin Paige, Piracy and Universal Jurisdiction, Macquarie Law Journal, vol. 12
(2013) pg. 148
2. Europian Research Financial Crises
3. Asian Crises pdf
4. Centre for international governance for financial crises pdf
5. European paper affecting Financial crises pdf

1. www.wikipidea.com
2. Investopedia.com

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