BPEA | 1996 No. 1

Financial Crises in Emerging Markets: The Lessons from 1995

Aaron Tornell,
Aaron Tornell University of California, Los Angeles
Andrés Velasco, and
Andrés Velasco
Andrés Velasco Dean, School of Public Policy - London School of Economics and Political Science, Former Minister of Finance - Chile
Jeffrey D. Sachs

1996, No. 1

THE MEXICAN PESO crisis of December 1994, and its reverberations in
the financial markets of developing countries around the world, has
intensified the debate over the nature of balance of payments crises in
developing countries. Many simple explanations have been given for
the crisis and its aftermath, but none of them does very well at accounting
for the main patterns of behavior in emerging markets during late
1994 and 1995. For example, many observers claim that it was Mexico’s
yawning current account deficit in 1994 that led to the drying up
of capital inflows, and thereby to the collapse of the peso. Nonetheless,
countries such as Malaysia and Thailand ran comparably large current
account deficits in 1990-94 (as a percentage of GDP) without suffering
reversals of capital inflows. Other observers claim that investor panic
spread contagiously from Mexico throughout emerging markets. This
story fits well with the strong adverse market reactions experienced by
Argentina and Brazil in early 1995, but not with the experiences of neighboring Chile and Colombia, which witnessed only slight and transitory
adverse market reactions.