Tel Aviv University
Fall Semester, 2015
Assaf Razin
Website : http://assaf-razin.com/
Email : razin@post.tau.ac.il
Office : Berglas 225
The Analytics of Global Financial Crises
Course Objectives:
The course provides reviews the analytics of financial fragilities,
underlying banking crises, and credit frictions, underlying debt crises.
These fragilities and frictions are rooted in coordination failures,
incentive problems, asymmetric information, risk shifting behavior, and
excessive optimism among participants in collateralized debt markets.
Each and every one of these forces is present in global financial problems
over last decades. The course reviews the analytics of currency crises and
balance of payments crises. Currency crises occur when the country is
trying to maintain a fixed exchange rate regime with capital mobility, but
faces conflicting policy needs, such as fiscal imbalances, or fragile
financial sector, that need to be resolved by independent monetary policy.
An important aspect of financial crises is the involvement of the
government and the potential collapse of arrangements it creates, such as
an exchange rate regime. Many currency crises, e.g., the early 1970s
breakdown of Bretton Woods global system, originate from the desire of
governments to maintain a fixed exchange rate regime which is
inconsistent with other policy goals. This might lead to the sudden
collapse of the regime. Such models are highly relevant to the current
situation in the European Monetary Union. In the basis of the theory of
currency crises is the famous international-finance tri-lemma, according
to which a country can choose only two of three policy goals: free
international capital flows, monetary autonomy, and the stability of the
exchange rate. Countries in the Euro zone now realize that in their
attempt to achieve the first and third goal, they have given up on the
second goal, and so have limited ability to absorb the shocks in economic
activity and maintain their national debts, triggered by the global
Coordination problems among investors and currency
financial crisis.
speculators aggravate this situation, and may have an important effect on
whether individual countries in Europe are forced to default and/or leave
the monetary union.
The third-generation models of currency crises connect models of
banking crises and credit frictions with traditional models of currency
crises. Such models were motivated by the East Asian Crises of the late
1990s, where financial institutions and exchange rate regimes collapsed
together, demonstrating the linkages between governments and financial
institutions that can expose the system to further fragility. The last part of
the course deals with key developments of New-Keynesian
macroeconomic paradigm: from an analytical framework which features
full capital-market arbitrage, smooth credit, Ricardian-equivalence
properties, representative agent, and efficient monetary management, to
the one, with multiple agents, incorporating debt frictions, liquidity trap,
relatively ineffective monetary management, which gives a role for fiscal
policy in aggregate demand management. The analytical framework
based on the frictionless paradigm, captures well the role of globalization
forces and the reduction in inflation in the 1990s Great Moderation era.
The multiple-agent, market-friction revised analytical framework
captures some key features of the Great Recession, in the aftermath of the
2008 global financial crisis. It gives insight about the macroeconomic
effects of debt overhang on the economic activity and inflation, when the
monetary policy rate reaches its lower bound.
Syllabus
(i) Historical Accounts of the 1990s Asian and the Japanese Crises,
The 2008 Global Financial Crisis and the Euro Crisis.
(ii) Fragilities of Financial Markets: Elements of the Theory
a. Banking Sector Fragility
b. Credit frictions
c. Asset bubbles
d. Currency Crises:
(iii) New-Classical Open Economy
Macroeconomics
1. Inflation and seigniorage
2. Exchange Rate
(iv) The New Keynesian Model
(v) New Macro-Finance Paradigm
a. Deleveraging and liquidity trap
b. Financial acceleration
c. Credit frictions in a full-fledged stochastic dynamic general
equilibrium model
Readings:
Jordi Galí Monetary Policy, Inflation, and the Business Cycle:
An Introduction to the New Keynesian Framework, Princeton University
Press, 2008. Chapters 1-5.
Assaf Razin: Understanding Global Financial Crises, MIT Press,
2015.Chapters 1-6, and 9-12.
Recommended:
Michael Woodford Interest and Prices: Foundations of a Theory of
Monetary Policy by
ISBN : 9780691010496, chapter 1-3.