Domestic Bank Regulation and Financial Crises: Theory and Empirical Evidence from East Asia Comment

Different from many other branches of international economics, the literature on currency attacks and financial meltdown cannot quite rely at least not for the time being on a “NeoClassical” theoretical core, that is, on a widely accepted, formally elegant paradigm linking pervasive normative implications to rigorous behavioral microfoundations. But in the absence of a “Neo-Classical” synthesis, the model of currency and financial crises that is rapidly emerging as the focal point in the recent body of research on causes and implications of market turbulence can be appropriately labeled as “Neo-Alexandrian” or better – “Neo-Alejandrian”. The “Alejandro” here is, of course, Carlos Diaz-Alejandro, author among many other things of the classic article “Good-bye financial repression, hello financial crash”. That article may well represent the mother of all papers on twin crises, judging from the number of “third-generation” models that keep building directly or indirectly on its insights fifteen years (and counting) since its publication. The chapter by Dekle and Kletzer in this volume is a highly enjoyable contribution to such “Neo-Alejandrian” paradigm, and a very fine one. Substantially, the “Neo-Alejandrian” paradigm relies on three building blocks. The first one is the overborrowing/overlending/overinvestment syndrome, that is, the role of lending booms in the build-up of a financial turmoil. The idea is that, to the extent that domestic and foreign creditors are willing to lend against future bail-out revenue, unprofitable projects, excessively risky investments, and cash shortfalls keep being refinanced and rolled over. In the case of foreign borrowing and evergreening, this translates into an unsustainable path of current account deficits.