Global financial instability: Framework, events, issues

In the last five years, the global economy has experienced severe bouts of financial instability that have had devastating impacts on crisis countries . Some examples of the impact on GDP are given in Table 1. In Mexico, GDP g rowth fell from above 4 percent in 1994 before the crisis to -6 percent in 1995. In Thailand, Malaysia, South Korea and Indonesia, GDP growth fell fro m above 5 percent in 1996 before the crisis to below -5 percent in 1998. Th ese swings of over 10 percent in rates of GDP growth are of the same order of magnitude as what occurred in the United States during the Great Depress ion. Two of the key questions facing policymakers today are how to reduce the ri sk of global financial instability and how to cope with it when it occurs. This paper starts by defining financial instability and then showing how it harms economic activity. It then uses this framework to describe what happ ened during the recent financial crises in Mexico and east Asia. The paper ends by raising several key policy issues not coincidentally, these issues are addressed in the remaining papers in the symposium.