P1:JtR 0521855241pre CB932-Aizenman 0521855241 August30,2005 20:48 This page intentionally left blank ii P1:JtR 0521855241pre CB932-Aizenman 0521855241 August30,2005 20:48 MANAGINGECONOMICVOLATILITYANDCRISES APractitioner’sGuide Overthepasttenyears,economicvolatilityhascomeintoitsownafterbeingtreated fordecadesasasecondaryphenomenoninthebusinesscycleliterature.Thisevolution has been driven by the recognition that nonlinearities, long buried by the economist’s penchantforlinearity,magnifythenegativeeffectsofvolatilityonlong-rungrowthand inequality,especiallyinpoorcountries.Goodtimesdonotoffsetthenegativeimpactof badtimes,whichleadstopermanentnegativeeffectsthatarereinforcedbyincomplete markets,sovereignrisk,divisivepolitics,inefficienttaxation,procyclicalfiscalpolicy, andweakfinancialmarketinstitutions.Thesamephenomenathatmakevolatilitydifficult tocopewithalsodriveeconomiccrises.Thisbookorganizesempiricalandpolicyresults for economists and development policy practitioners into four parts: basic features, includingtheimpactofvolatilityongrowthandpoverty;commoditypricevolatility;the financialsector’sdualroleasanabsorberandamplifierofshocks;andthemanagement and prevention of macroeconomic crises. The latter section includes a cross-country study,casestudiesonArgentinaandRussia,andlessonsfromthedebtdefaultepisodes ofthe1980sand1990s. Joshua Aizenman is Professor of Economics at the University of California, Santa Cruz.PriortohisappointmentatUCSC,hewasChampionProfessorofInternational EconomicsatDartmouthCollege.ProfessorAizenman’sotheraffiliationshaveincluded teaching and research positions at the University of Pennsylvania, the University of Chicago Graduate School of Business, and the Hebrew University in Jerusalem. He has held consultancies with the International Monetary Fund, the World Bank, the Inter-American Development Bank, and the Federal Reserve Bank of San Francisco. His research covers a range of issues in open economy including commercial and financial policies, crises in emerging markets, foreign direct investment, capital con- trols, and exchange rate regimes. Professor Aizenman also serves as a Research AssociatefortheNationalBureauofEconomicResearch. BrianPintohasbeenattheWorldBank,Washington,DC,formorethan20years.He iscurrentlyEconomicAdviserintheEconomicPolicyandDebtDepartment,Poverty Reduction and Economic Management Anchor. Past assignments in the World Bank Groupincludestintsinborrowingoperations,theInternationalFinanceCorporation,and theEuropeandCentralAsiaRegion.Dr.PintolivedandworkedinPolandatthestartofits momentousreforms(1990–92)andsubsequentlyinRussiaduringaperiodwhichcovered its 1998 crisis and subsequent recovery (1998–2001). His areas of expertise include policy-orientedanalysesofmacroeconomiccrisesandrecovery,publicdebtdynamics, and transition economics. His publications have appeared in numerous professional journals. i P1:JtR 0521855241pre CB932-Aizenman 0521855241 August30,2005 20:48 ii P1:JtR 0521855241pre CB932-Aizenman 0521855241 August30,2005 20:48 MANAGING ECONOMIC VOLATILITY AND CRISES A Practitioner’s Guide Editedby JOSHUA AIZENMAN UniversityofCalifornia,SantaCruz BRIAN PINTO TheWorldBank iii cambridge university press Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo Cambridge University Press The Edinburgh Building, Cambridge cb2 2ru,UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Informationonthistitle:www.cambrid ge.org/9780521855242 ©TheWorldBank2005 This publication is in copyright. Subject to statutory exception and to the provision of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published in print format 2005 isbn-13 978-0-511-14003-7 eBook (EBL) isbn-10 0-511-14003-7 eBook (EBL) isbn-13 978-0-521-85524-2 hardback isbn-10 0-521-85524-1 hardback Cambridge University Press has no responsibility for the persistence or accuracy of urls for external or third-party internet websites referred to in this publication, and does not guaranteethatanycontentonsuchwebsitesis,orwillremain,accurateorappropriate. P1:JtR 0521855241pre CB932-Aizenman 0521855241 August30,2005 20:48 ToMichalandourdaughters,AviandAnbar Tomymother,Praxedes,andthememoryofmyfather,HughPinto v P1:JtR 0521855241pre CB932-Aizenman 0521855241 August30,2005 20:48 vi P1:JtR 0521855241pre CB932-Aizenman 0521855241 August30,2005 20:48 Contents Contributors page ix Acknowledgments xi Foreword xiii Overview 1 JoshuaAizenmanandBrianPinto PARTI. WHATISVOLATILITYANDWHYDOESITMATTER? 1. Volatility:DefinitionsandConsequences 45 HolgerWolf 2. VolatilityandGrowth 65 ViktoriaHnatkovskaandNormanLoayza 3. Volatility,IncomeDistribution,andPoverty 101 ThomasLaursenandSandeepMahajan PARTII. COMMODITYPRICESANDVOLATILITY 4. AgriculturalCommodityPriceVolatility 137 JanDehn,ChristopherGilbert,andPanosVarangis 5. ManagingOilBoomsandBustsinDevelopingCountries 186 JuliaDevlinandMichaelLewin PARTIII. FINANCEANDVOLATILITY 6. FinanceandVolatility 213 StijnClaessens 7. EvaluatingPricingSignalsfromtheBondMarkets 281 JohnJ.Merrick,Jr. PARTIV. MANAGINGCRISES 8. ManagingMacroeconomicCrises:PolicyLessons 315 JeffreyFrankelandShang-JinWei vii P1:JtR 0521855241pre CB932-Aizenman 0521855241 August30,2005 20:48 viii Contents 9. LessonsfromtheRussianCrisisof1998andRecovery 406 BrianPinto,EvseyGurvich,andSergeiUlatov 10. Argentina’sMacroeconomicCollapse:CausesandLessons 439 LuisServe´nandGuillermoPerry 11. DefaultEpisodesinthe1980sand1990s:WhatHaveWeLearned? 471 PunamChuhanandFedericoSturzenegger TechnicalAppendix 521 ViktoriaHnatkovska Index 567