Perspective Paper on Financial Instability

By Peter Blair Henry
2004| Working Paper No. 1866

Financial instability is a major problem for the worlds middle-income developing countries. Barry Eichengreens proposal for dealing with the problem treats currency mismatchesthe fact that developing countries borrow in dollars instead of their own currencyas the principal cause. I argue that institutional flaws, with monetary and fiscal policy for example, drive financial instability and also account for countries inability to place local-currency denominated debt contracts. Since weak institutions are to blame, efforts to help countries build stronger institutions will likely yield greater benefits than narrow attempts to address currency mismatches per se.

financial crises
international finance
economic development