During the past few years, many countries have suffered severe currency and banking crises, producing a staggering toll on their economies, particularly in emerging-market countries. In many cases, the cost of restructuring the banking sector has been in excess of 20 per cent of GDP, and output declines in the wake of crisis have been as large as 14 per cent. An increasingly popular view blames fixed exchange rates, specifically “soft pegs, ” for these financial meltdowns. Not surprisingly, adherents to that view advise emerging markets to join the ranks of the United States and other industrial countries that have chosen to allow their currency to float freely. (See, for example, Goldstein 1999.) At first glance, the world—with the notable exception of Europe—does seem to be marching steadily towards floating exchange rate arrangements. According to the International Monetary Fund (IMF), 97 per cent of its member countries in 1970 were classified as having a pegged exchange rate; by 1980, that share had declined to 39 per cent, and in 1999, it was down to only 11 per cent. 1 Yet, this much-used IMF classification takes at face value that countries actually do what they say they do. Even a cursory perusal of the Asian crisis countries ’ exchange rates prior to the 1997 crisis would suggest that their exchange rates looked very much like pegs to the U.S. dollar for extended periods of time. Only Thailand, however, was explicitly classified as a peg; the Philippines was listed as having a freely floating

In the wake of the Mexican and Asian currency turmoil, the subject of financial crises has come to the forefront of academic and policy discussions. This paper analyzes the links between banking and currency crises. We find that: problems in the banking sector typically precede a currency crisis—the currency crisis deepens the banking crisis, activating a vicious spiral; financial liberalization often precedes banking crises. The anatomy of these episodes suggests that crises occur as the economy enters a recession, following a prolonged boom in economic activity that was fueled by credit, capital inflows, and accompanied by an overvalued currency.

Capital flow and commodity cycles have long been connected with economic crises. Sparse historical data, however, has made it difficult to connect their timing. We date turning points in global capital flows and commodity prices across two centuries and provide estimates from alternative data sources. We then document a strong overlap between the ebb and flow of financial capital, the commodity price super-cycle, and sovereign defaults since 1815. The results have implications for today, as many emerging markets are facing a double bust in capital inflows and commodity prices, making them vulnerable to crises.

We examine the evolution of real per capita GDP around 100 systemic banking crises. Part of the costs of these crises owes to the protracted nature of recovery. On average, it takes about 8 years to reach the pre-crisis level of income; the median is about 6.5 years. Five to six years after the onset of crisis, only Germany and the United States (out of 12 systemic cases) have reached their 2007-2008 peaks in real income. Forty-five percent of the episodes recorded double dips. Post-war business cycles are not the relevant comparator for the recent crises in advanced economies.

The Federal Reserve's mandate has evolved considerably over the organization's hundred-year history. It was changed from an initial focus in 1913 on financial stability, to fiscal financing in World War II and its aftermath, to a strong anti-inflation focus from the late 1970s, and then back to greater emphasis on financial stability since the Great Contraction. Yet, as the Fed's mandate has expanded in recent years, its range of instruments has narrowed, partly based on a misguided belief in the inherent stability of financial markets. We argue for a return to multiple instruments, including a more active role for reserve requirements.

Newly developed historical time series on public debt, along with data on external debts, allow a deeper analysis of the debt cycles underlying serial debt and banking crises. We test three related hypotheses at both “world” aggregate levels and on an individual country basis. First, external debt surges are an antecedent to banking crises. Second, banking crises (domestic and those in financial centers) often precede or accompany sovereign debt crises; we find they help predict them. Third, public borrowing surges ahead of external sovereign default, as governments have “hidden domestic debts” that exceed the better documented levels of external debt.

Economics

A year ago, we presented a historical analysis comparing the run-up to the 2007 US subprime financial crisis with the antecedents of other banking crises in advanced economies since World War II (Reinhart and Rogoff 2008a ). We showed that standard indicators for the United States, such as asset price inflation, rising lever age, large sustained current account deficits, and a slowing trajectory of economic growth, exhibited virtually all the signs of a country on the verge of a financial crisis—indeed, a severe one. In this paper, we engage in a similar com

Is the 2007-2008 U.S. sub-prime mortgage financial crisis truly a new and different phenomena? Our examination of the longer historical record finds stunning qualitative and quantitative parallels to 18 earlier post-war banking crises in industrialized countries. Specifically, the run-up in U.S. equity and housing prices (which, for countries experiencing large capital inflows, stands out as the best leading indicator in the financial crisis literature) closely tracks the average of the earlier crises. Another important parallel is the inverted v-shape curve for output growth the U.S. experienced as its economy slowed in the eve of the crisis. Among other indicators, the run-up in U.S. public debt and is actually somewhat below the average of other episodes, and its pre-crisis inflation level is also lower. On the other hand, the United States current account deficit trajectory is worse than average. A critical question is whether the U.S. crisis will prove similar to the most severe industrialized-country crises, in which case growth may fall significantly below trend for an extended period. Or will it prove like one of the milder episodes, where the recovery is relatively fast? Much will depend on how large the shock to the financial system proves to be and, to a lesser extent, on the efficacy of the subsequent policy response.