Current Account and External Financing: an Introduction

Economic analysts were surprised by the collapse of the Thai baht in July 1997. In the months that followed, most of the so-called East Asian Tigers faced severe balance-of-payments crises, and a year later, in August 1998, the Russian ruble was devalued. As a result of this succession of crises, the economics profession rethought many of its views on macroeconomic management. Lessons were drawn from the experience, and policy blueprints for avoiding future crises were developed. One of the key issues that emerged from the discussion is whether international capital markets are a source of stable and reliable financing, reacting optimally to changing global saving and investment patterns and conditions in emerging market economies, or whether they are a source of instability for these economies. The fact that many emerging economies with prudent macroeconomic policies have been hit by crises suggests that financing may be a source of instability. Further support of the “erratic finance” view is a historical pattern in emerging markets of current account deficits that grow when output is high—in apparent contradiction to the standard textbook model of the current account. Moreover, the question remains as to whether individual agents in emerging market economies will behave optimally in this erratic world, limiting their borrowing in anticipation of the next sudden stop, or whether they will act as if every