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Created 11/20/1998
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for the Haas School teach-in on the international monetary crisis.
November 20, 1998, International House, U.C. Berkeley.


East Asia's Crisis--and Ours

J. Bradford DeLong
delong@econ.berkeley.edu
http://www.j-bradford-delong.net


The version given at Laura Tyson's November 20 teach-in

Back in the 1890s and 1900s international capital flows were of great benefit to the world. Flows of money and investment from the center to the periphery of the world economy allowed investors in the capital-rich core to earn higher rates of return than they would have otherwise, and allowed workers in the resource-rich periphery access to the fixed and working capital they needed to multiply their productivity--and hence their wages.

In the 1920s and 1930s international capital flows--interacting with attempts to restore the pre-World War I monetary order--did great harm to the world economy. Rational and less-than-rational fears of heightened taxation, of devaluation, and of depression caused country after country to suffer large-scale capital flight. Central bank and finance ministry beliefs that long-run growth required holding on to the gold standard led them to induce recessions in order to defend the gold standard. In the end defense of the gold standard proved incredible: the political will to continue the defense drained away as unemployment deepened in the Great Depression, and all that the combination of international capital flows and government commitment to the gold standard did was to make the Great Depression much greater than it would otherwise have been.

The architects of the Bretton Woods system that governed international monetary arrangements in the 1950s and 1960s had lived through the 1920s and 1930s. They were eager to embrace controls on international capital flows, which they saw as bringing little more than trouble: destabilizing speculation, irrational capital flight, and the potential for chains of contagious panic like that that had brought on the Great Depression. Stable exchange rates (so that world trade could develop and expand) and governments committed to preventing serious depressions at home seemed much more important than encouraging the free flow of international capital.

But with the breakdown of the Bretton Woods fixed exchange-rate system in the 1970s, the political retreat from social democracy in the 1980s, and the fading of the memory of the Great Depression, the pendulum swung back once again. The first generation of post-World War II economists would have said "yes." The second and third generations of post-World War II economists regretted the fact that capital controls kept people with money to lend in industrial countries away from people who could make good use of the money to expand economic growth in developing economies, and noted that capital controls were not working effectively anyway as ingenious investors found more and more ways around them. The balance of opinion shifted to the view that the world economy was sacrificing too much in the way of economic growth to be worth whatever reduction in instability capital controls produced.

So now we have all the benefits of free flows of international capital. These benefits are mammoth: the ability to borrow abroad kept the Reagan deficits from crushing U.S. economic growth like an egg, and the ability to borrow from abroad has enabled successful emerging market economies to double or triple the speed at which their productivity levels and living standards converge to the industrial core.

But the free flow of financial capital is also giving us one major international financial crisis every two years.

If you read your newspapers the flood of capital out of East Asia is blamed on a lack of democracy, on crony capitalism, official corruption, over-extended banks, and an absence of honest and trustworthy corporate and government accounts. But a lack of democracy, high-level corruption, banks making loans to the politically well-connected, the absence of trustworthy accounts, crony capitalism--all these were as salient and as troubling back when East Asia was the darlings of the international capital market, the place to be for anyone who wanted to be surfing the leading edge of the wave of financial opportunity.

And corruption in East Asia in the 1990s does not seem qualitatively different from corruption in the United States back in the 1870s. Robber barons like Leland Stanford would have had little to learn about crony capitalism from anyone in Indonesia today. As principal of the Central Pacific railroad he gave sweetheart construction contracts to construction firms that he himself owned. As governor and ex-governor he could channel massive government subsidies to the Central Pacific. A lot of money flowed out of the pockets of British investors and California taxpayers into the pockets of Leland Stanford in the 1860s and 1870s--money that was to later form the core of the endowment of Leland Stanford Junior University. Yet the U.S. economy grew rapidly--and overseas investors in the U.S. profited greatly--in the second half of the nineteenth century: that a rapidly-industrializing country is corrupt does not mean that it is not a profitable place in which to invest.

Instead, the root cause of the crises was a sudden change of state in international investors' opinions. Like a herd of not-very-smart cattle, they all were going one way in 1993 or 1996, and then they turned around and are all going the opposite way today. Economists will dispute which movement was less rational: Was the stampede of capital into emerging markets an irrational mania disconnected from fundamentals of profit and business, or is the stampede of captal out of emerging markets today an irrational panic? The correct answer is probably "yes"--the market was manic, it is now panicked, and the sudden change in opinion reflects not a cool judgment of changing fundamentals but instead a sudden psychological victory of fear over greed.

So what is to be done?

In the current international monetary system it is assumed that one reaction to a crisis will be a devaluation: since the world economy has signalled that it is no longer willing to pay as much for a country's capital or goods as before, a devaluation is a way of reducing the price of a whole nation's goods, the analogue to a firm cutting its prices in response to falling demand. But devaluation does little good if the value of the debts owed by a country in crisis rise as the currency falls in value: if the banks and firms in a country in crisis have borrowed not in their local currency, but in dollars, pounds, yen, or marks.

If the depreciation and the hard-currency debts are large enough, the consequence is general bankruptcy and financial collapse, and general bankruptcy and financial collapse are the stuff of which Great Depressions are made.

A government may, as part of an inflation-control program, have promised that it would not let its exchange rate depreciate. The commitment that one's currency is fixed in terms of the dollar or the deutschmark or the pound or the yen is an important tool often used to convince people that the government is committed to an anti-inflation policy. So depreciate your currency and you may wind up with a sudden burst of inflation.

But avoiding depreciation is no solution either. Because everyone notices that demand for your products and assets has fallen, everyone concludes that your exchange rate is highly likely to fall. So everyone requires enormous interest rates in order to keep their money invested in your country. And enormously high interest rates make investment unprofitable and worsen the balance sheet of all financial institutions that have loaned long-term and borrowed short-term. Once again the consequence is general bankruptcy and financial collapse--the stuff of which Great Depressions are made.

Hence here enters the International Monetary Fund. As its role has evolved over the past generation, the IMF exists to make "structural adjustment" loans to countries that have--either because of bad and unsustainable policies pursued by their governments or because of bad luck in terms of the shocks inflicted on them by the world economy--gotten into this kind of financial trouble. The IMF makes the process of adjustment easier by lending hard currency to countries to allow them to take steps to turn their economy around gradually. But the IMF expects to get its money back: so the IMF requires that countries that borrow from it adopt economic policies that make it confident that it will indeed be repaid.

I happen to believe that the IMF got it just about right in East Asia, in Thailand, Indonesia and South Korea. Others disagree--although those who disapprove of the IMF disapprove of one another's criticisms even more, and prescribe inconsistent and opposed remedies. But I don't have time to get into that now. So let me assume the IMF got it right.

So if the IMF got it right, why is there still a crisis? We are now nineteen months into this particular financial crisis. Nineteen months after the start of the EMS crisis in 1992, or the Mexican crisis in 1994, the crisis was over--economies were growing rapidly again, and the fear and panic of the crisis months were fading memories.

There is still a crisis because the East Asian economies have been hit by another shock--the worsening Japanese recession. There is a worldwide crisis because the East Asian crisis in 1997 was followed by an--independently caused--crisis in 1998: the Russian default.

But the Russian default, coming so soon after the East Asian crisis, made investors all around the world believe that the world was a much more risky place than they had thought. Hence "contagion" and a "flight to quality" as all over the world people try to shift their wealth out of leveraged emerging-market equity, out of risky investments, and into safe investments in strong currencies like the government bonds of major financial-center countries. Over the course of the summer and fall the worldwide structure of asset prices has rotated: anything less risky than the U.S. stock market has risen sharply in price--U.S. government bonds, for example, on which the Federal Reserve has cut interest rates--and anything more risky has fallen in price. The result has been one spectacular hedge-fund bankruptcy--LTCM--an increase in capital flight from emerging markets like Brazil, and a general feeling that financial markets are still highly vulnerable to downward shocks.

The size of this flight to quality has been surprisingly large. The IMF blames "...technical factors... Highly leveraged investors [who] had to realise assets to meet margin calls... [selling] in the most liquid markets to raise cash." And it calls for financial regulators in all countries to take steps to change their systems to increase investor confidence that assets and companies widely thought to be sound are in fact sound: "greater transparency of positions being taken by investors... controls on excessive leverage... differential reserve requirements against loans to different countries depending on their banking standards." And perhaps the IMF will call for Chilean-style, market-based measures to regulate inflows of short-term capital.

So what is to be done?

In the short term, first, the central banks of the industrial core should make sure that there are enough less-risky, "quality" securities to meet demand as investors flee to less-risky, "quality" securities: buy back people's bonds for cash, and lend freely to institutions and market participants that are not insolvent but merely illiquid. This policy is being carried out. Thus the three lowerings of short-term interest rates by the U.S. Federal Reserve over the course of this fall. And the declaration by European central bankers that after the January 1, 1999 launch of European monetary union that Europe-wide interest rates should be at the low levels currently seen in France and Germany.

Second, deal with Japan's recession. Rapid action to recapitalize its banks, and further fiscal stimulus, would go a long way to help Japan and the rest of Asia recover. This policy is not being carried out, or is not being carried out well.

Third, keep the smoldering embers of the crisis from bursting into flame through a large-scale epsiode of depreciation and capital flight in Brazil. Some of this needs to be done by President Cardoso and the rest of the Brazilian government: Brazil needs to balance its budget so that investors do not worry that the Brazilian government will start printing money to pay its bills and that high inflation will return. But the rest of this needs to be done by the rest of the world: enough financial support to allow Brazil to withstand speculative attacks, and lower interest rates in the world as a whole to make it more costly for Brazilians to bet on a large forthcoming depreciation.

It is not clear whether or not the Brazilian government will accomplish its tasks.

In the longer run, it is less clear what needs to be done. If sudden changes of opinion by international investors cause so much trouble, shouldn't we keep such sudden changes of opinion from having destructive effects? Shouldn't we use capital controls and other devices to keep international flows of investment small, manageable, and firmly corralled?

Perhaps. How to build a better system is not clear.

The answer is probably that we should try to have the benefits of free capital mobility while also setting up institutions to strictly limit how much damage is done by international financial crises. But how to do so is not clear. We do not have a perfect international economic system. We do not know how to build a better one. So we need to make sure that we manage this one that we have as carefully and prudently as possible.


A longer and somewhat different version, not given...

We are now watching the third international financial crisis in six years. The first was the collapse of the European Monetary System in 1992, the second was the unpleasantness surrounding the Mexican peso in 1994-5, and the third is the current crisis--beginning in East Asia in the middle of last year--but which has spread or has threatened to spread to places as diverse as Brazil, Russia, and Greenwich, Connecticut.

One major financial crisis every two years is rather a lot, suggesting deep problems in the international financial system itself. So what should we have done differently? What can we do now to fix things? And how should people deal with the crisis that is currently rolling forward?

The root of the crisis in East Asia in 1997 was a sudden change of heart on the part of investors in the world economy's industrial core--in New York, Frankfurt, London, and Tokyo. In East Asia in 1996 international investors poured perhaps $70 billion into the region's economies. In 1998--even though East Asian currencies have been lowered far enough to create some equally amazing bargains for those seeking long-term investments--the net private capital flow will be -$30 billion.

If you read your newspapers the flood of capital out of East Asia is blamed on a lack of democracy, on crony capitalism, official corruption, over-extended banks, and an absence of honest and trustworthy corporate and government accounts. But a lack of democracy, high-level corruption, banks making loans to the politically well-connected, the absence of trustworthy accounts, crony capitalism--all these were as salient and as troubling back when East Asia was the darlings of the international capital market, the place to be for anyone who wanted to be surfing the leading edge of the wave of financial opportunity.

The root cause of the crises is a sudden change of state in international investors' opinions. Like a herd of not-very-smart cows, they all were going one way in 1996, and then they turned around and are all going the opposite way today. Economists will dispute which movement was less rational: Was the stampede of capital into emerging markets an irrational mania disconnected from fundamentals of profit and business, or was the stampede of capital out of emerging markets an irrational panic? The correct answer is probably "yes"--the market was manic, and it is now panicked, and the sudden change in opinion reflects not a cool judgment of changing fundamentals but instead a sudden psychological victory of fear over greed.


Dealing with Capital Flight

What should a country do when international investors who have been eager to invest in almost anything--the peak of irrationality was reached in the early eighteenth-century South Sea bubble in England, when one entrepreneur successfully sold shares in "an enterprise that cannot now be revealed, but that promises to be of great advantage"--suddenly change their minds? What to do when the overseas market of people willing to spend tens of billions a year or so to buy new factories in your country suddenly vanishes?

The natural thing for a country to do when demand for its products--either for what it exports, or for ownership of factories located within its borders--falls is to do what a business does when demand for its products falls: when demand falls, you cut your price. The easiest way for a country to cut its price is to make its currency worth less: a depreciation or devaluation. Then, without any of your companies having to make decisions or reprint catalogs, all of the products made within your borders are suddenly cheaper and more attractive to foreigners.

But there are two problems with exchange rate depreciation as a way for a country to handle a sudden fall in demand for its products or its assets. The first is that its government may, as part of an inflation-control program, have promised that it would not let its exchange rate depreciate. The commitment that one's currency is fixed in terms of the dollar or the deutschmark or the pound or the yen is an important tool often used to convince people that the government is committed to an anti-inflation policy. So depreciate your currency and you may wind up with a sudden burst of inflation.

Moreover, in many cases you will find that your banks or your companies have borrowed abroad in amounts denominated in dollars, or deutschmarks, or yen. In this case a depreciation raises the home-currency value of the debts that your banks and companies owe. If the depreciation and the hard-currency debts are large enough, the consequence is general bankruptcy and financial collapse, and general bankruptcy and financial collapse are the stuff of which Great Depressions are made.

But avoiding depreciation is no solution either. Because everyone notices that demand for your products and assets has fallen, everyone concludes that your exchange rate is highly likely to fall. So everyone requires enormous interest rates in order to keep their money invested in your country. And enormously high interest rates make investment unprofitable and worsen the balance sheet of all financial institutions that have loaned long-term and borrowed short-term. Once again the consequence is general bankruptcy and financial collapse--the stuff of which Great Depressions are made.

Hence here enters the International Monetary Fund. As its role has evolved over the past generation, the IMF exists to make "structural adjustment" loans to countries that have--either because of bad and unsustainable policies pursued by their governments or because of bad luck in terms of the shocks inflicted on them by the world economy--gotten into this kind of financial trouble. The IMF makes the process of adjustment easier by lending hard currency to countries to allow them to take steps to turn their economy around gradually. But the IMF expects to get its money back: so the IMF requires that countries that borrow from it adopt economic policies that make it confident that it will indeed be repaid.


The IMF in East Asia

I happen to believe that the IMF got it just about right in East Asia, in Thailand, Indonesia and South Korea. The IMF loaned them a lot of money, so that they could avoid the nasty choice between immediate default and separation from the world economy on the one hand and the massive shock of dealing with capital flight without reserves on the other. The IMF loans allowed countries to adjust to the sudden fall in world demand for their assets gradually, and thus avoid much of the disruption and economic chaos that could follow from sudden adjustment to a negative shock.

The IMF also recommended--required--substantial cuts in government spending, boosts in taxes, and higher interest rates. Interest rates had to be raised in order to keep the exchange rate from collapsing completely, with the hope that after the first wave of panic had passed that interest rates could be allowed to fall again. In the case of South Korea and Thailand, where currencies are now stable in ranges about 35-40% below pre-crisis levels and short-term interest rates are below pre-crisis levels, this hope appears to have been justified.

Some criticized temporary high interest rates as unduly contractionary. They failed to observe that further massive depreciation caused by lower rates in an environment of panic would have raised the burden of dollar-denominated debts and caused the complete collapse of East Asian financial systems. While the burdens imposed by higher interest rates were temporary, those that would have been created by deeper massive exchange rate depreciations would have been permanent.

Some criticized any exchange rate depreciation at all--calling it a breaking of the government's promise to maintain a constant link with the dollar. They failed to observe that raising interest rates so high as to keep exchange rates from falling in an environment of panic would have bankrupted all financial institutions which borrowed short-term and loaned long-term, thus causing the complete collapse of East Asian financial systems. While the disruptions to confidence caused by abandonment of pledges to maintain fixed parities vis-a-vis the dollar were temporary, those that would have been created by maintaining fixed exchange rates would have been permanent.

There is a point of balance here, of finding the least harmful policy, and I think that the IMF has done a pretty good job of keeping close to it.

Now hindsight is always 20-20, and in retrospect--had they known then what we know now--the IMF would have been better done some things differently. IMF Principal Deputy Managing Director Stanley Fischer has observed that had the IMF known in the summer of 1997 how massive the forthcoming economic slowdown in Japan--and the rest of Asia--would be, they would not have recommended--required--fiscal contraction. And the IMF is now advocating "more fiscal expansion, including additional social spending for the poor" for Indonesia, Thailand, and South Korea. I also am skeptical of the inclusion of "structural measures"--the reform of financial organization and systems of corporate control--as part of the IMF package. It seems to me that we don't know enough about how such systems really work: remember that what is now called East Asian "crony capitalism" was a superior system of financial and corporate organization only a decade ago, and that East Asian financial and corporate organizations did over the past generation support the most rapid industrial growth the world has ever seen.

There are many critics of the IMF: those who think it loaned too little with too many conditions, those who think it loaned too much with too few conditions, those who dislike the IMF because they think it could have avoided recessions in East Asia but didn't, those who dislike the IMF because they think it did significantly alleviate recessions in East Asia but think that higher unemployment in East Asia is a good thing because it will teach East Asians who deserve to suffer not to borrow so much, those who dislike the IMF because they think it did significantly alleviate recessions in East Asia but think that higher unemployment in East Asia is a good thing because it will teach financiers in New York who deserve to suffer not to lend so much, those who think that IMF lending helps the unworthy and creates "moral hazard" that will cause future crises, those who think that IMF lending is insufficient and does not provide an adequate level of insurance against less-than-rational speculative attacks, et cetera, et cetera. But they disagree with one another much more than they disagree with the Fund, and they advise the Fund to change its policies in radically different and contradictory ways.

Of all the criticisms of the IMF, the one that I think is the most wrong-headed is the claim that the IMF creates "moral hazard" and induces people to take over-risky positions in the belief that if things turn wrong the IMF will always rescue them.
This doesn't apply to governments: most do their utmost to avoid borrowing from the IMF. This doesn't apply to the bulk of investors: most investors in Asia and Russia who bet on the "moral-hazard play" have taken very heavy losses indeed. And much more serious than "moral hazard" are the costs of the IMF failing to do its job by providing insurance against financial crises.


The Situation Worsens

So if the IMF got it right, why is there still a crisis? We are now nineteen months into this particular financial crisis. Nineteen months after the start of the EMS crisis in 1992, or the Mexican crisis in 1994, the crisis was over--economies were growing rapidly again, and the fear and panic of the crisis months were fading memories.

There is still a crisis because the East Asian economies have been hit by another shock--the worsening Japanese recession. Rapid export growth to the United States helped bring Mexico out of its 1994-95 crisis. But while exports from Thailand, Indonesia and South Korea to both Europe and America have been rising, their exports to Japan have declined sharply in the past year, by about 25%. So exports have not, so far, served as a source of growth.

Thus there are today important signs of progress in both Korea and Thailand, in the stabilization of their currencies, the fall in interest rates, and the ongoing recapitalization of their financial systems. But the economic--and political--outlook in Indonesia and Malaysia is significantly worse. And production has not yet started increasing again even in Korea and Thailand. The East Asian financial crisis is not over.

But what made the situation worsen significantly in 1998 was the crisis in Russia.

Now Russia has been in crisis--political and economic--since the start of the 1980s. Odds that economic reform would be successful were always low: Russia did not have that good a chance of following the path that the Czech Republic, Poland, Slovenia, and Hungary are following that will bring them to western European modes of social organization and levels of prosperity in a generation. Russia's reformers never had full control over economic policy. The coexistence of a large politically-influential group of ex-communist managers who want to hold on to what they have with a politically-influential group of ex-communist politicians who want things the way they used to be have immobilized the government. Corruption is a huge problem. Successive executive governments have been too weak to implement their desired policies, and there has been no leadership from the legislature.

In July the IMF assembled a package of $22 billion for Russia, to be disbursed on the conditions that the Russians undertake major tax reforms and restructure their large government debt. But the Duma rejected two tax measures, the package was not disbursed, the ruble was devalued, the Russian government unilaterally reduced the value of its debt, and suspended payment of private debts. It is hard to believe that these steps were that much of a shock to confidence. After all, the sophisticated investors who had earned an average of 50% a year on Russia's government debt since 1994 knew that these investments were very risky, and that the government might well wind up confiscating their principal.

But the Russian default, coming so soon after the East Asian crisis, made investors all around the world believe that the world was a much more risky place than they had thought. Hence "contagion" and a "flight to quality" as all over the world people try to shift their wealth out of leveraged emerging-market equity, out of risky investments, and into safe investments in strong currencies like the government bonds of major financial-center countries. Over the course of the summer and fall the worldwide structure of asset prices has rotated: anything less risky than the U.S. stock market has risen sharply in price--U.S. government bonds, for example, on which the Federal Reserve has cut interest rates--and anything more risky has fallen in price. The result has been one spectacular hedge-fund bankruptcy--LTCM--an increase in capital flight from emerging markets like Brazil, and a general feeling that financial markets are still highly vulnerable to downward shocks.

The size of this flight to quality has been surprisingly large. The IMF blames "...technical factors... Highly leveraged investors [who] had to realise assets to meet margin calls... [selling] in the most liquid markets to raise cash." And it calls for financial regulators in all countries to take steps to change their systems to increase investor confidence that assets and companies widely thought to be sound are in fact sound: "greater transparency of positions being taken by investors... controls on excessive leverage... differential reserve requirements against loans to different countries depending on their banking standards." And perhaps the IMF will call for Chilean-style, market-based measures to regulate inflows of short-term capital.


What Is To Be Done?

So what is to be done?

In the short term, first, the central banks of the industrial core should make sure that there are enough less-risky, "quality" securities to meet demand as investors flee to less-risky, "quality" securities: buy back people's bonds for cash, and lend freely to institutions and market participants that are not insolvent but merely illiquid. This policy is being carried out. Thus the three lowerings of short-term interest rates by the U.S. Federal Reserve over the course of this fall. And the declaration by European central bankers that after the January 1, 1999 launch of European monetary union that Europe-wide interest rates should be at the low levels currently seen in France and Germany.

Second, deal with Japan's recession. Rapid action to recapitalize its banks, and further fiscal stimulus, would go a long way to help Japan and the rest of Asia recover. This policy is not being carried out, or is not being carried out well.

Third, keep the smoldering embers of the crisis from bursting into flame through a large-scale epsiode of depreciation and capital flight in Brazil. Some of this needs to be done by President Cardoso and the rest of the Brazilian government: Brazil needs to balance its budget so that investors do not worry that the Brazilian government will start printing money to pay its bills and that high inflation will return. But the rest of this needs to be done by the rest of the world: enough financial support to allow Brazil to withstand speculative attacks, and lower interest rates in the world as a whole to make it more costly for Brazilians to bet on a large forthcoming depreciation.

It is not clear whether or not the Brazilian government will accomplish its tasks.

In the longer run, it is less clear what needs to be done. If sudden changes of opinion by international investors cause so much trouble, shouldn't we keep such sudden changes of opinion from having destructive effects? Shouldn't we use capital controls and other devices to keep international flows of investment small, manageable, and firmly corralled? The first generation of post-World War II economists would have said "yes." The second and third generations of post-World War II economists regretted the fact that capital controls kept people with money to lend in industrial countries away from people who could make good use of the money to expand economic growth in developing economies, and noted that capital controls were not working effectively anyway as ingenious investors found more and more ways around them. The balance of opinion shifted to the view that the world economy was sacrificing too much in the way of economic growth to be worth whatever reduction in instability capital controls produced.

So now we have all the benefits of free flows of international capital. These benefits are mammoth: the ability to borrow abroad kept the Reagan deficits from crushing U.S. economic growth like an egg, and the ability to borrow from abroad has enabled successful emerging market economies to double or triple the speed at which their productivity levels and living standards converge to the industrial core.

But the free flow of financial capital is also giving us one major international financial crisis every two years.

So what is to be done?

The answer is probably that we should try to have our cake and eat it too--have the benefits of free capital mobility while also setting up institutions to strictly limit how much damage is done by international financial crises. The rules for how to try to handle a financial panic were codified a central and a quarter ago by Walter Bagehot, editor of the London Economist. He had three rules. First, in times of panic some central bank or lender-of-last-resort must throw money--not grants, but loans--at the problem: must "in time of panic... advance [money] freely and vigorously to the public.... The end is to stay the panic, and the advances [of money] should [be large enough]... to stay the panic. Second, calling for help in a panic must be expensive--governments, banks, businesses that draw on emergency lines of credit to get them through a panic must pay high enough interest to make the experience an unpleasant one that no one would willingly go through again. Third, rescuers must be willing to separate sheep from goats, and lend only to solvent institutions and governments that will--if the panic is halted--eventually be able to pay the loan back.

We do not have a perfect international economic system. We do not know how to build a better one. So we need to make sure that we manage this one that we have as carefully and prudently as possible.


Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/

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