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Liquidity and Twin Crises

2. Twin Crises. Banking crisis combined with currency crisisKorea 1997Mexico 1994Germany 1931. 3. Policy Dilemma. High interest ratesRaise cost of speculationIncrease attractiveness of holding domestic currencyHigh interest ratesLower asset valuesLower net asset value of domestic banking s

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Liquidity and Twin Crises

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    1. 1 Liquidity and Twin Crises Hyun Song Shin London School of Economics

    2. 2 Twin Crises Banking crisis combined with currency crisis Korea 1997 Mexico 1994 Germany 1931

    3. 3 Policy Dilemma High interest rates Raise cost of speculation Increase attractiveness of holding domestic currency High interest rates Lower asset values Lower net asset value of domestic banking system Precipitate run by foreign creditor banks

    4. 4 Mark to Market Accounting Transparency Ex ante incentives, moral hazard Measurement of counterparty risk But measurement implies actions Reacting to price changes Amplifying price changes Measuring counterparty risk determines counterparty risk

    5. 5 Twin Crisis as Liquidity Black Hole Korean bank�s balance sheet (in won) p is price of domestic asset D is dollar liability to foreign bank e is exchange rate (high e = strong won)

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