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Summary and Next Step Major financial crises since the 1990s started at a corner of the world economy and spread across the world like wildfire. ” True, “fundamentals” deteriorated during crises, but this was largely an outcome, not a cause. • These features are shared by emerging and developed market economies alike. Market reforms are probably necessary to avoid further crises, but there is still no role model that can be followed as policy guide. • 22 Chapter 1 The challenge is to develop a framework in which financial crises have causes that go far beyond standard “fundamentals” and have deleterious effects on regions and markets that, at first, may appear largely disconnected to the epicenter (or initial location) of the crisis.

See Obstfeld et al. 11 Liquidity Crunch and Sudden Stops: Collateral Damage A liquidity crunch episode, like the one that took place around the Lehman crisis, can have severe effects on credit flows. Large and largely unexpected contractions of credit flows are called Sudden Stops (SS). 12 SS can hit an economy as a whole, as was the case in EM financial crises, or just a subsector, as in the US real estate market in the wake of the Lehman crisis episode (in which case term-mismatch between assets and liabilities may wreak chaos, even if contracts are denominated in the same unit of account; see below).

I discuss Keynes’s conjecture in Calvo (2012 a) and call it the Price Theory of Money (PTM). 9 It is extraordinary that to this day this kind of guarantee that holds in all capitalist economies has largely been overlooked by the micro- and macro-literature. I suspect the omission stems from the lack of a deep discussion of liquidity issues in macroeconomics and also the obliteration of price/wage stickiness issues from microeconomics. The PTM offers a partial rationale for the resilience of the dollar relative to other liquid assets.