A MODEL OF CRISES IN EMERGING MARKETS Michael P. Dooley Working Paper 6300NBER WORKING PAPER SERIES A MODEL OF CRISES IN EMERGING MARKETS Michael P. Dooley Working Paper 6300 bp://www.nber.org/papers/w6300 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 December 1997 | thank Robert Flood for helpful comments. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. © 1997 by Michael P. Dooley. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.‘A Model of Crises in Emerging Markets Michael P. Dooley ‘NBER Working Paper No. 6300 December 1997 JEL Nos. F32, F34 ABSTRACT First generation models of speculative attacks show that apparently random speculative attacks on policy regimes can be fully consistent with rational and well-informed speculative behavior. Unfortunately, models driven by a conflict between exchange rate policy and other ‘macroeconomic objectives do not seem consistent with important empirical regularities surrounding, recent crises in emerging markets. This has generated considerable interest in models that associate crises with self-fulfilling shifts in private expectations. In this paper we develop a first generation model based on an alternative policy conflict. Credit constrained governments accumulate reserve assets in order to self-insure against shocks to national consumption. Goverments also insure poorly regulated domestic financial markets. Given this policy regime, a variety of internal and external shocks generate capital inflows to emerging markets followed by successful and anticipated speculative attacks. ‘We argue that a common external shock generated capital inflows to emerging markets in ‘Asia and Latin America after 1989. Country specific factors determined the timing of speculative attacks. Lending policies of industrial country governments and international organizations account for contagion, that is, a bunching of attacks over time. Michael P. Dooley Department of Economics Social Sciences 1 University of California, Santa Cruz Santa Cruz, CA 95064 and NBER mpd@cats.uesd.edu