Understanding Financial Crises: Some Implications for Financial and Debt Policy

The central objective of this discussion paper is to present a simple explanation of recent financial crises and, on that basis, to discuss some policy options for individual countries. Systemic policies are not discussed. More emphasis is put on understanding the nature of these crises than on providing a list of policies. Section II discusses the current crisis, which has come to be known as the subprime crisis. The central point is that there is essentially nothing new under the sun. Section II also discusses the impact of the subprime crisis on emerging market economies, and offers an interpretation of a remarkable phenomenon that, surprisingly, is ignored in much of the debate, namely, that emerging markets today are, on average, faring relatively well. Section III offers a brief summary of current research on emerging market crises, which highlights the role of balance sheet imbalances. It is mostly intended to show how the findings about financial vulnerabilities highlighted in this note can be brought to bear. Special attention is paid to debt management policies.