Paper tigers? A model of the Asian crisis

This paper develops an interpretation of the Asian meltdown focused on mora l hazard as the common source of overinvestment, excessive external borrowi ng, and current account deficits. To the extent that foreign creditors are willing to lend to domestic agents against future bail-out revenue from the government, unprofitable projects and cash shortfalls are re-financed thro ugh external borrowing. While public deficits need not be high before a cri sis, the eventual refusal of foreign creditors to refinance the country's c umulative losses forces the government to step in and guarantee the outstan ding stock of external liabilities. To satisfy solvency, the government mus t then undertake appropriate domestic fiscal reforms, possibly involving re course to seigniorage revenues. Expectations of inflationary financing thus cause a collapse of the currency and anticipate the event of a financial c risis. (C) 1999 Elsevier Science B.V. All rights reserved.