Editors' Summary

Editors' Summary The brookings panel on Economic Activity held its seventy-fifth conference in Washington, D.C., on March 27 and 28, 2003. This issue of Brookings Papers on Economic Activity includes the papers and discussions presented at the conference. The first paper explores why some emerging market economies are prone to fall into financial crisis at levels of external indebtedness that more advanced economies, and even some other developing economies, seem able to manage. The second paper reviews the current U.S. fiscal situation against the historical record and finds the present is so different that the past is an unreliable guide to how either the economy or future policy will respond. The third paper offers a theoretical analysis of optimal monetary policy in the face of a liquidity trap, with a focus on the importance of expectations. The fourth paper discusses a new methodological approach to economic policymaking under uncertainty, with particular attention to uncertainty about economic models. The concluding report analyzes whether new rules for corporate pension accounting promulgated in the 1980s misled investors into over-valuing the stocks of firms with pension plans during the 1990s market boom. Developing economies have been vulnerable to financial crises for a long time and under a wide range of exchange rate regimes and international financial structures. Although economists have used theoretical models to explore the link between a country's external debt and its vulnerability to crisis, little empirical work has been done to quantify that link or to identify what makes some countries more vulnerable than others. In the first paper of this volume, Carmen Reinhart, Kenneth Rogoff, and Miguel Savastano draw on the experience of a large number of countries at different stages of development to address these issues. Their perspective is informed by a number of observations about individual [End Page ix] countries' ability to borrow. Advanced industrial countries typically have access to international capital markets irrespective of their debt burdens. The poorest countries, by contrast, are simply shut out of these markets. The large group of middle-income countries find that their access varies with their economic situation. The authors introduce the concept of "debt intolerance" to describe the fact that some countries are more likely than others to get into financial trouble from taking on a given amount of debt. They also attempt to quantify debt intolerance and the factors that lead to it. Sovereign defaults have a long history. The authors record sixteen defaults by European nations between 1501 and 1800, a period for which data are probably incomplete, and no fewer than thirty European defaults in the nineteenth century. Focusing on present-day emerging market economies, they show a close association between a country's recent Institutional Investor rating (IIR), which reflects the views of economists and analysts from the financial community about a country's creditworthiness, and its long-term record with respect to default or debt restructuring. (Calculations of country risk based on market yield spreads give rankings similar to the IIR, but data on yields for many countries' debt are available only for recent years.) Focusing on a sample of emerging market economies, and using data that go back at least a few decades and to 1824 for most, the authors show that those with at least one external default or restructuring had an average IIR of 42 in 2002, whereas those with no history of default had an average rating of 62 that year. By comparison, the ratings of six advanced economies with no history of default average 89. The authors also show a large difference in inflation experience across these groups. Countries in the lowest IIR category in 2002 spent, on average, one quarter of the past forty-two years with annual inflation exceeding 40 percent. The authors note that most of the countries with some history of default are "serial defaulters." Most have spent roughly a quarter of the time for which the authors have data in a state of default or restructuring, and Mexico has been in this condition nearly half the time. The ability to borrow freely is a hallmark of developed financial markets, which help channel funds to efficient uses. And default in...