Journal of International Economics 72 (2007) 512–514www.elsevier.com/locate/econbase

Book review

Emerging Capital Markets in Turmoil, Guillermo Calvo. MIT Press, (2005)

1. Introduction

This book is a collection of Guillermo Calvo's “greatest hits” dedicated to all those who dare tothink outside the box, but are prudent in expressing their ideas. This is exactly what Calvo hasaccomplished in this compilation of papers about financial crises. The book provides a lucidelaboration of the dialogue between academic ideas, policies and historical events that haveshaped the current paradigm with which economists understand financial crisis. As an undisputedleader in academic and policy circles, Guillermo Calvo is in a privileged position to be thenarrator of the recent history of economic thought about financial crises. The book is stronglyrecommended to anyone interested in financial markets in emerging countries, from journalistsand policy makers to economic professionals and graduate students.

The book highlights Calvo's unique characteristics. His writing flows indiscernibly from theoryto practice in an interplay between academic insights and key facts that will entice readers. He hasbeen a key player in helping academics and policymakers a-like change their “old views” about theroots of financial crises for new concepts that have revealed to be at the center of recent crises. Theprocess through which this core set of concepts has emerged is the main focus of the book.

2. Sketch of the book

The book is divided in five parts. The first part, entitled Early Rumblings, describes theimportance that external factors have in shaping the performance of certain emerging economies.It uses two of his early writings to show that “old ideas die hard.” Part II elaborates on the mainlessons from the Mexican, Russian and Argentine crises which helped build the new set oftheories that currently dominate among economists. These theories are explained in part III, InSearch of a Theory. This part is more technical, but as the author points out can be skippedwithout loss of generality. The last two parts of the book deal with highly controversial topics, theexchange rate regime debate and the notion of credibility and time-consistency. To maintain thesame logic of the book, this review is organized in a similar way.

The first part of the book highlights the puzzling similarity of outcomes in the 1970s and 1990sacross Latin American countries despite the divergence of objective conditions observed acrossthese countries. In joint work with Leonardo Leiderman and Carmen Reinhart, they show howfalls in U.S. interest rates can lead to large capital inflows and periods of economic boom withindependence of the nature of domestic policy. While external factors have been confirmed asstrong predictors of economic activity (see for instance Borensztein et al., 2001; Broda, 2001),these ideas are still hard to accept today. One reason for this is because these ideas imply that luckcan determine the fate of countries with independence of policy (see Easterly et al., 1993 for a

doi:10.1016/j.jinteco.2007.02.002

513Book review

more general analysis of this point entitled “Good Policy or Good Luck?). Calvo, who at the timeworked at the IMF, mentions how the IMF had a lukewarm reaction to this research. Interestingly,Calvo suggests that the IMF would risk its influence with the region's policy makers by openlyaccepting that the region's success was in great part due to sheer luck.

History repeats itself. Since 2002, most Latin American economies have been booming. Someare placing price controls, taxing or prohibiting exports, and allowing for private contracts to beviolated daily. Others are signing free trade agreements, de-regulating energy sectors and beingconsistent over time. The contrasts cannot be bigger. However, the whole region is growing fast ataround 6% per year. As I will mention below, the current period differs in many respects to theearly 1990s, but the reader will find these early writings as highly relevant for thinking about thepresent of these countries. For instance, the positive co-movement across countries in thebehavior of capital inflows, official reserves, exchange rates and even stock prices is also presenttoday as it was in the 1970s and 1990s.

In part II, Calvo reviews the lessons of recent crisis with a bias towards financial factors.References to classic topics like fiscal and current account deficits and currency overvaluation aredownplayed in an attempt to re-direct the focus to financial variables. Instead, short-term foreignexchange debt, liquidity squeezes in world capital markets and foreign reserves take center stage.The Mexican experience is a clear case in point. Despite conventional-wisdom argumentsfavoring the devaluation as the best policy to counteract the large current account deficits andovervaluation, the attempt at correcting these imbalances using the exchange rate triggered a deepcrisis that traditional “vulnerability” indicators could not foresee.

Calvo has a knack for creating buzz words in the academic literature. “Liability dollarization”and “sudden stops” are just two of these words that have transcended the academic circles and arenow commonly referred to in the press and financial markets. The crux of the book lies in thesechapters, as events help shape and highlight the importance of financial factors in explaining thesecrises. Calvo is careful not to dismiss issues related to fiscal considerations, but believes thatwithout the financial ones, it is hard to explain the debacle scenarios observed after some of thesecrises. This is especially true in Chapter 6, where he evaluates the causes of the Argentine 2001crises.

Calvo is skeptic about how much policy makers have learnt from the past. Although fewrecognize it, the recent boom in all Latin America has much to do with extremely favorableexternal conditions. However, as opposed to earlier “common” booms, today the region as awhole has “twin surpluses” in terms of current account and fiscal balances. It has also reduced itsdollar exposure in public and private debt. At the very least, some policy makers are now aware ofthe dangers of “liability dollarization” and “sudden stops.” Whether they are fully prepared tocope with the next downturn is a different matter.

The next part of the book – the more technical one – explains how the so-called firstgeneration models (Salant and Henderson, 1978; Krugman, 1979) have a hard time explaining thevariety of capital market crises observed in the last decade. Thus, the self-fulfilling nature of crisesintroduced by Obstfeld (1986) is explained, together with the role played by imperfectinformation in magnifying crises which was first inspired by the Russian 1998 crises. Facts andtests for rational contagion appear throughout this part (for another clear exposition on contagion,see Rigobon, 2003). The goal of this line of research is to provide the practitioner with a freshmenu of warning indicators and policies to prevent crises.

In the last chapters of the book, Calvo makes a compelling case that talking about the exchangerate regime without context is useless. In particular, he discusses the anachronism of the optimal-currency-area criteria to determine optimal exchange rate regimes and points to several factors left

514 Book review

out, which have taken prominence since the 1960s, when Mundell wrote the theory. Theconclusion from the analysis (best summarized in Chapter 17, in joint work with Rick Mishkin) isthe choice of exchange rate regime is likely to be of second order of importance to thedevelopment of good fiscal, financial, and monetary institutions in producing macroeconomicsuccess in emerging market countries. As in other parts of the book, this provides a synthesis for aview that has become widespread: a focus on institutional reforms rather than on the exchangerate regime may encourage emerging market countries to be healthier and less prone to the crisesthat we have seen in recent years.

The book takes the reader through particular events that helped shape the new set ofmainstream concepts used to understand financial crises. Although Calvo remains skeptical abouthow much governments and financial markets have internalized the new theories of financialcrises, in recent years we have seen changes attest for at least a partial success of the ideas hehelped pioneer. We have much to thank him for these changes, and for his relentless search for thesolutions of these maladies that are constantly impoverishing people in developing countries.

References

Broda, C., 2001. Coping with terms-of-trade shocks: peg versus floats. American Economic Review 91 (2) (May).Borensztein, E., Zettelmeyer, J., Philippon, T., 2001. Monetary independence in emerging markets: does the exchange rate

regime make a difference? IMF Working Paper, vol. 01/1. January.Easterly, Kremer, W.M., Pritchett, L., Summers, L., 1993. Good policy of good luck? Country growth performance and

temporary shocks. Journal of Monetary Economics 32.Krugman, 1979. A model of balance-of-payments crises. Journal of Money, Credit and Banking 11, 311–325 (August).Rigobon, 2003. On the measurement of the international propagation of shocks: are they stable? Journal of International

Economics 61, 261–283.Obstfeld, M., 1986. Rational and Self-Fulfilling Balance-of-Payments Crises. American Economic Review (March).Salant, Henderson, 1978. Market anticipations of government policies and the price of gold. Journal of Political Economy

96, 627–648.

Christian BrodaUniversity of Chicago, GSB, 5807 S Woodlawn Ave, Chicago, IL 60637, United States

E-mail address: cbroda@chicagogsb.edu.Tel.: +1 773 841 1608; fax: +1 773 702 0458.