The results in Table 3 and 4 illustrate the big swings in both directions of the debt-toGDP ratios for individual MACs, but there is an asymmetry. Debt levels rise suddenly and by large amounts following crises; achieving subsequent reductions is slow. What these tables do not show is that the timing of the fiscal adjustment, i.e., a big increase in the primary fiscal surplus, is typically forced by the crisis itself. The impact of the market is demonstrated by the large role played by the real interest rate and the real exchange rate during the debt increase episodes. These often force large knock-on costs in connection with financial sector bailouts as a result of balance sheet currency mismatches and the impact of high real interest rates. In contrast, debt reduction episodes involve growth and fiscal effort, which typically require more time to yield tangible benefits. The results are similar to those found in IMF (2003).<sup>28</sup> With this background, the next three sections attempt answers to the questions posed at the outset: Is the world on the verge of a debt crisis? Is public debt helping or hurting growth? What is being done—by developing countries and by international institutions—about this?

# **4. WHAT IS THE LIKELIHOOD OF ANOTHER 1980s-TYPE DEBT CRISIS?**

What are the risks of another generalized debt crisis as in 1982? Our answer is “Such risks have receded since the late 1990s, but this doesn’t mean that such a crisis will not appear in the future.” One would be at odds with history for saying otherwise—as noted in Easterly, Islam and Stiglitz (2000), “Crises have been a constant of market capitalism...”, including not just financial shocks, but also wars, pestilence and natural disasters. One might also add that crises rarely tend to be similar—witness the successive generations of crisis models—making them difficult to predict.

Nevertheless, some guidance may be extracted from recent financial contagion episodes. Kaminsky, Reinhart and Vegh (2003) [KRV] compare cases where an exchange rate collapse or sovereign default in one country led to immediate and widespread cross-border contagion with cases where this did not happen. They conclude that the first set of cases is distinguished by three key factors: (i) a rapid build up of capital flows in the period preceding the currency collapse or default announcement (this is an obvious pre-requisite for a sudden stop); (ii) a surprise announcement of a float or default; (iii) presence of a common leveraged creditor.

These three factors certainly applied to the 1982 crisis, where petrodollars were recycled by the money center banks to MACs, those in Latin America in particular. The surprise announcement was the Mexican default in August 1982. The affected countries were hurt by commodity price declines and a big rise in US interest rates over 1980-85. The US banks, which were heavily exposed to Mexico, withdrew from emerging markets, and with the exception of Chile, Colombia and Costa Rica, all the Latin American countries defaulted. The wave of crises in MACs after Thailand announced the flotation of the baht in July 1997 was also preceded by substantial capital flows into the affected countries, as shown in Table 2. The common external shock identified by KRV was the large depreciation of the yen against the dollar, to which most of the East Asian currencies were pegged, between April 1995 and April 1997. Japanese banks retreated from East Asia; the Korean crisis prompted European banks to do so as well. Likewise, the Russian default and devaluation of August 17, 1998, led to ripple effects in Brazil and eventually in Argentina, and possibly Turkey. The Russian crisis precipitated the bailout of Long-Term Capital Management (LTCM), a heavily leveraged hedge fund with systemic links to

> 28 IMF (2003a), Chapter III, notes: “The rise (in public debt in MACs since the mid-1990s) appears to be largely accounted for by interest and exchange rate movements and the recognition of off-balance-sheet and contingent liabilities...”

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