We build a model of financial sector illiquidity in an open economy. Illiquidity defined as a situation in which a country's consolidated financial system has potential short-term obligations in foreign currency that exceed the amount of foreign currency it can have access to on short notice can be associated with self fulfilling bank and/or currency crises. We focus on the policy implications of the model, and study the role of capital inflows and the maturity of external debt, the way in which real exchange rate depreciation can transmit and magnify the effects of bank illiquidity, options for financial regulation, the role of debt and deficits, and the implications of adopting different exchange rate regimes.
*Published: This paper was subsequently published as Liquidity Crises in Emerging Markets: Theory and Policy, Roberto Chang, Andrés Velasco, in NBER book NBER Macroeconomics Annual 1999, Volume 14 (2000)
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