Currency and financial crises : dividing the (negative) spoil
Following the 1997 Asian Crisis, a number of economies have been burdened with so-called Twin Crises, facing both vulnerable exchange rates and a distressed financial sector. The three papers in this thesis examine the resolution of a twin crisis in one such country - Indonesia. In debt overhang and exchange rate collapse, I adopt the simplest representation of the economy and the Asian crisis. The model is a modified Hecksher-Ohlin framework with labour as the sole domestic factor. The crisis is triggered by a terms of trade shock. The analysis implies that workers have already suffered a wealth loss in the form of a wage cut. If they are inclined to pay all the overhang, they will take another cut - a large one - due to the so-called overhang multiplier. In Indonesian cronies' tardy crisis resolution skills, both the underlying model and the description of the crisis are made more realistic. The model has another domestic factor added to allow for the existence of domestic capitalists. The crisis is triggered by two additional factors; a loss of confidence by foreign investors and an end to a domestic subsidy on foreign capital. Until agreement is reached on the overhang, the economy suffers so-called corporate decay. I introduce the cronies, and show that it may be optimal for them to stall agreement, even if there is perfect information. Contrary to conventional wisdom, bankruptcy reforms do not necessarily hasten agreement, though they do improve the payoffs to the international creditors. In debt forgiveness, I examine the pessimistic scenario that Indonesia becomes like a Highly Indebted Poor Country (HIPC), so that all the issues related to debt forgiveness become relevant. I improve a contract arising from a workhorse model of debt forgiveness, showing a better way to provide reform incentives for countries heavily in debt.