Increased Capital Mobility and Financial Crisis

Abstract

Regarding the consideration that the short/intermediate run effect of capital movement is more important than that of the long run, this paper exposes a dark side of crisis generation by employing a few features discussed in the literature on financial crises. By means of a simple IS-LM type model it examines to macro economy the effects of such factors as self-fulfilling pessimism, balance sheet effect, contractionary effect of devaluation and vicious circle tossed in the context of financial crisis. Policy implications related with the dark side of international capital movement, in distinction to the naive optimism of the neoclassical model are as follows: Currency mismatch can be avoided to get rid of balance sheet effect due to high indebtedness, stabilization of exchange rate can be attempted as it would obviate the malicious pessimism of self-fulfilling exchange rate expectation, the most severe loss in net worth activating the balance sheet problem usually arises with the severe depreciation, capital movement can be somehow managed to overcome sudden stops and hence avoid malicious depreciation.