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Fiscal Consequences of Financial Crises

Carmen M. Reinhart,
University of Maryland, NBER
Schwartz Economic Symposium, September 15, 2009
based on:
This Time is Different:
Eight Centuries of Financial Folly
with Kenneth S. Rogoff
(Princeton University Press, 2009)
As to the fiscal aftermath of
banking crises, we find:
 That the nearly universal focus on
calculations of bailout costs as the
centerpiece of the fiscal consequences of
banking crises is misguided and incomplete.
 Banking crises weaken fiscal positions
beyond the costs of bailouts, as government
revenues contract and stimulus plans find
favor.
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Financial crises are historically
associated with the “deadly D’s”
 Sharp economic downturns follow banking
crises;
 with government revenues shrinking, fiscal
deficits worsen;
 deficits lead to debt;
 as debt piles up rating downgrades follow.
 For the most fortunate countries, the crisis does
not lead to the deadliest D:
 default, but for many it has.

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On the first point, the discrepancies across
estimates of bail-out costs are large and in,
some cases, staggering

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Fiscal deficits as a percent of GDP

Country (crisis year) Year b

Argentina, 2001
Chile, 1980 Reinhart and Rogoff 5
On the second point, government
revenues suffer as the crisis lingers

Real Governm ent ReveuesandBankingCrises


(annual percent changes)

2
Percent

0
t-3 t-2 t-1 T t+1 t+2 t+3
-1
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Thus, the true legacy of financial
crises is more government debt…
Cumulativeincreasein public debt in thethreeyears following
thebankingcrisis

Malasia
Mexico Index=100in year of crisis
Japan
Norway
Philippines
Korea Averageis186.3
Sweden
Thailand
Average
Spain
Indonesia
Chile
Finland
Colombia Reinhart and Rogoff 7
Institutional Investor sovereign r
Peak-to-trough index declines (l

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Policy issues going forward
 Soaring debt: Policy makers should be concerned
about the debt levels (explicit and implicit) that it is
likely to take on as it works its way out of the crisis

 Financial crises are “hardy perennials”-- regulation


needs to be constantly revised and revisited to “keep
up” with market innovation.

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