Working Paper no. 46

A Krugman-Dooley-Sachs Third-Generation Model of The Asian Financial Crisis

Gregor Irwin and David Vines (December 1999)

 This paper presents a multiple-equilibrium model of the Asian financial crisis. The economy has Krugman-style over-investment caused by weak financial regulation and exacerbated by government guarantees. Following Dooley, the government only has a limited capacity or willingness to honour such guarantees. The model has a unique long run equilibrium, with over-investment. But in the short-run, in which the capital stock is fixed, it also has multiple equilibria. If lenders regard lending as low-risk, then it is. But if they regard lending as high-risk and charge a risk premium, then the costs of honouring guarantees rises, making the lending high-risk and justifying the risk premium. We argue that this model usefully captures the ideas of panic and collapse which have been popularised in Sachs’ discussions of the Asian crisis.

Gregor Irwin: Lady Margaret Hall, Oxford; gregor.irwin@economics.ox.ac.uk. David Vines: Institute of Economics and Statistics, Manor Rd, Oxford, OX1 3UL; tel: ( 44) 1865 271067; fax: (44) 1865 271094; david.vines@economics.ox.ac.uk

Working Paper no. 47

Is Article XXIV Bad?

Ben Zissimos and David Vines (December 1999)

The current polarisation in the world trade system towards regional block formation could threaten further multilateral trade liberalisation. This paper identifies the incentive structure created by Article XXIV itself, the set of WTO rules governing trade block formation, as an impediment to the multilateral liberalisation process. Even if external tariffs are not allowed to rise, as stipulated by Article XXIV, there is a terms of trade externality to trade block formation and expansion. This benefits members (even relative to free trade) but the rest of the world suffers. “Open Regionalism” is shown not to provide a viable solution. Ben Zissimmos: Centre for the Study of Globalisation and Regionalisation, University of Warwick, and Institute of Economics and Statistics, University of Oxford. Address: IES, Manor Road, Oxford OX1 3UL; tel +(44) 1865 271086; fax (44) 1865 27109; benjamin.zissimos@economics.ox.ac.uk.David Vines: details as given for previous working paper.