financial crises dissertation

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Essays on financial crises.

Macroeconomics was born as a result of one of the worst financial collapses in human history: the 1930's great depression. Since then, a rich and comprehensive literature on the causes and economic consequences of financial crises has arisen. However, despite our ever-growing understanding of extreme financial events, the evolutionary nature of the world economy implies that crises continue to occur in both, known and unknown shapes and forms. As shown by the 2008's great recession, economists and policymakers often find themselves voiceless when confronted with the unexpected outcomes of modern-day financial collapses.

This dissertation studies financial crises in emerging and developing countries. We focus on these countries because seventy-five percent of all the registered events of financial distress that occurred between 1970 and 2010, happened in these economies (Reihart and Rogoff, 2011). The chapters presented in this document, investigate the three main subjects associated with financial crises: origins, prevention, and management.

Economists have been very successful in understanding the causes and consequences of financial crises over, among others, income, trade, employment, and poverty. However, when determining policy mechanisms that allow for effective prevention and efficient management policies, results have been mixed. This dissertation contributes to the literature by proposing an innovative perspective on the prevention and management of financial crises.

Chapters 1 and 2 focus on the roots of financial crises and the formulation of optimal macroprudential policy. Specifically, we look at different scenarios in which imperfect credit markets lead to an increase in the frequency and the severity of financial collapses. We study the characteristics of the optimal policy that minimizes the occurrence of crises and restores efficiency in the market. Chapter \ref{chap:ch1} analyzes the relationship between information frictions and financial constraints. In particular, we relax the perfect information assumption in a small open economy with collateral constraints. Under such a condition, households observe income growth but do not perceive whether the underlying shocks are permanent or transitory. We find that the likelihood and severity of financial crises increase due to the interaction between the information friction and a pecuniary externality that emerges when households use an asset valued at market prices as collateral. Our results also show that the optimal tax to restore constrained efficiency is six times larger than under perfect information.

Chapter 2 provides a quantitative link between the macroeconomic relevance of overborrowing and the significance of permanent shocks to the economy. We propose an innovative approach to estimate the unobservable permanent and transitory components of income and show that as the transitory-to-permanent volatility ratio decreases, the degree of overborrowing in a decentralized economy converges to zero. Moreover, as the permanent shocks to income become more relevant to the economy, the number of crises occurring because of overborrowing falls.

In chapter 3, we turn our attention to the case of economies with highly indebted governments that are forced to reduce their Debt-to-GDP ratio in order to bring the budget under control. The chapter proposes a quantitative framework that sheds light on the optimal path that authorities can follow to achieve fiscal consolidation. We argue that the optimal design of a consolidation plan must consider the transition dynamics of the economy and maximize either welfare or another measure of prosperity. Our quantitative model explores the case of small open economies under different monetary policy regimes. We conclude that currency devaluation is a critical factor in stabilizing output during a fiscal contraction.

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Senior Thesis Spotlight: Her Affinity for Service Took an Unexpected Turn Toward Public Policy

The daughter and granddaughter of physicians, Natalia Lalin entered Princeton with a strong affinity for service and an intention to major in neuroscience.

But after taking a wide swath of courses during her first year — including mathematics, computer science, and, especially, the Freshman Seminar “Sentencing and Punishment” — she began to reimagine her academic path with an eye toward public policy coursework at the Princeton School of Public and International Affairs (SPIA).

The summer following her sophomore year, she interned in U.S. Rep. Mikie Sherrill’s office on Capitol Hill, where she networked with Princeton alumni in Washington, including Chris Lu ’88, the U.S. Ambassador to the United Nations for U.N. Management and Reform, and Lisa Brown ’82, general counsel of the U.S. Department of Education. The experience taught her that giving back comes in many forms — not just medicine — and she returned to the University as a SPIA major.

“Service is so broad, and there are so many other opportunities that you can engage in, especially in policy and law,” Lalin says. “I wanted to do that in an area that I was most passionate about, and I found that that was in SPIA.”

As a junior, Lalin deepened her exploration of public service. She served as a research assistant with SPIA’s Bridging Divides Initiative, where she investigated political violence and election monitoring, and participated in a Policy Task Force, “Multilateralism in crisis? How international institutions can better manage global challenges,” about the challenges that international institutions face and how they might become more effective.

“That launched me more into the human- and civil-rights sphere,” Lalin says. For her junior year research seminar, Lalin explored law and policy in India, and the structural barriers women face with respect to High Court and Supreme Court appointments in the country’s public law sphere.

The summer following her junior year was, to say the least, busy. Lalin began by interning in the civil society division of the United Nations Entity for Gender Equality and the Empowerment of Women — U.N. Women — where she worked to connect youth activists from the world to the U.N. Network. From there, she went to the Division on Civil Rights at the New Jersey Attorney General’s office, where she investigated cases of housing discrimination. That fall, she studied abroad at the University of Cambridge, in England.

For her senior thesis, she chose to research the effects of China’s Belt and Road Initiative (BRI) on Sri Lanka, the homeland of her father and her maternal grandparents. Through BRI, China has been loaning large sums of money to Sri Lanka and other countries. When Sri Lanka failed to repay its loan, China took control of one of its ports, Hambantota, stirring American fears that it could be used as a military foothold in the Indian Ocean.

“That was criticized in the very early days of BRI as an example of its dark side,” says Lalin’s thesis adviser, Martin Flaherty ’81, a visiting professor of public and international affairs. “And then the scholarship moved on to other countries. But what Natalia is doing is returning to this original story, and in a very interesting way.”

Lalin traveled to Sri Lanka at the end of last summer to conduct interviews with key stakeholders. She spoke with some 20 corporate leaders, government officials, ambassadors, policy experts, community advocates, journalists, and academics, and also gleaned insights from ordinary Sri Lankans she encountered between the formal interviews. “When you talk to people in Sri Lanka, they say, ‘It’s actually not [just] the People’s Republic of China,’” Lalin said. “‘We need to hold our own [Sri Lankan] politicians accountable.’”

“My thesis puts forth that the primary onus is on the People’s Republic of China,” she said, given concerns about rule of law, economics and other aspects of sovereignty. These include facilitating foreign interference in domestic affairs, increased corruption, environmental degradation disproportionately affecting poorer communities, censorship and an erosion of labor rights.

Flaherty said that supports the conventional wisdom about BRI, which holds that the policy exploits developing countries by offering loans for infrastructure projects that they cannot pay — so-called “debt trap diplomacy.”  Sri Lanka is often cited as a prime example of this narrative, because it ostensibly lost control of an entire port as collateral for unpaid loans. He praised Lalin for adding nuance to that narrative.

“Among other things, Natalia’s in-country interviews reveal a far more complex story,” he said. “On one hand, conventional accounts of the Hambantota story are not entirely accurate.  At the same time, Natalia nonetheless demonstrates other ways that the influence of BRI has negative effects in Sri Lanka, including promotion of corruption, labor problems and human rights issues.

Lalin’s thesis notes that despite warnings from the International Monetary Fund, the Sri Lankan government instituted tax cuts that hurt the country’s overall GDP at a time when its economy was already in decline. It also issued an import ban on non-organic fertilizers, hoping to enhance domestic production; when that didn’t happen, crops failed and a food shortage followed.

“These policies, which were supposed to restore the country after its war, had the opposite effect, as they plummeted Sri Lanka into financial ruin,” she writes. “As a result, Sri Lanka was ill-prepared to face the polycrisis that came with the 2020s. The country was hit from every angle, from a global pandemic and huge drop-off in tourism, which the country’s economy relied on, to an increase in oil and gas prices as a result of the Russia-Ukraine War.”

“A lot of students would’ve gone in there just trying to undermine the conventional story and then come out 180 degrees opposite,” Flaherty said. “What Natalia did was undermine the conventional story, but also come up with a deeper account that gives a much better understanding.”

As a Princeton graduate, Flaherty brought his own experience to bear on the critical role of senior thesis adviser. He said his own adviser, John Murrin, a professor of history who specialized in American colonial and revolutionary history and the early republic and taught at Princeton for 30 years, was “phenomenal.” His thesis, “A Region Converted: A History of Early Princeton, 1683-1813,” garnered three awards presented at Commencement.

As he worked with Lalin over the course of this academic year, he said that having written a thesis of his own made him “appreciate how substantial and important” the thesis experience is at Princeton.

After she graduates, Lalin plans to work for two years as a legal analyst at a law firm. Law school will follow, likely with a focus on international law.

“I want to continue working in the human rights space,” Lalin says. “My long, long, long-term goal would be to be an ambassador,” possibly to Sri Lanka, “and really bring my life full circle.”

Ask an Expert: Examining the Collective Trauma of War with Cari Jo Clark

The public health impact of armed conflict and war have immediate, visible ramifications on entire populations, along with long-term health effects that span generations. Humanitarian crises unfolding in Gaza, Yemen, Sudan, Somalia, Democratic Republic of the Congo, and more are living examples of this.   

Aside from the direct physical harms resulting from combat and bombings, there are also associated health outcomes caused by or made worse by war including:   

• Infectious disease spread  
• Increased sexual and domestic violence  
• The lack of basic medical services due to damaged or destroyed health care infrastructures   
• Limited or no access to clean water and sanitation  
• Starvation and malnutrition   
• Environmental exposures   
• Mental health degradation   

Cari Jo Clark, ScD, associate professor of global health, has spent much of her career working in developing countries and humanitarian zones impacted by war. Her area of interest is strongly centered in understanding the factors that shape women’s risk of violence in settings of natural and human-made disasters.   

“Even in times of war, women's exposure to domestic violence continues to be the predominant exposure of violence in most conflicts,” says Clark. “In most settings, it's a continuation or an exacerbation of what was already going on beforehand. And then the conflict setting just changes the dynamics and increases risks for women.  

“If you want to reduce women's risk of violence, it's very easy. The answer is in politics and patriarchy. There are people in charge who can change women's lives dramatically with hard decisions.” But it is not a high enough political priority.    

Here, she shares her insights on the human cost of war through the lens of research and her personal experiences working with refugees and people living in containment settings.   

Talk to me a bit about the impact of conflict and containment on intimate partner violence.

We saw during COVID how difficult it was for domestic violence survivors to get out and get help. There was more stress and financial insecurity, mobility restrictions, making it more difficult to diffuse or deescalate tense situations, so escalation was more likely.   

In conflict settings, we see increased rates of intimate partner violence too due to several things, including stress, insecurity, the proliferation of weapons, militarization of everyday behavior, and at least temporary normative changes that can challenge pre-existing gender roles, obligations, and opportunities.    

As you’re watching what’s happening to people in Gaza right now and in other active conflict zones, what are the biggest threats you’re seeing to health? 

In Gaza, the entire health care infrastructure has been destroyed. It isn’t just the short-term impact on people, communities, livelihoods, and the health system that we are seeing with conflicts. In instances like Gaza, it will be decades of damage and a collective trauma on both sides that has shaken everyone’s sense of security, safety, and well-being. The human, social and physical infrastructure of communities is being undone.   

What does research tell us about how war and exposure to violence impact various societies’ concepts of masculinity? 

There has been some really interesting research in Gaza and the West Bank looking at how war gets played out on women's bodies. So you saw women's roles changing quite dramatically. That sort of role-change in the household led to some men feeling emasculated and having their concepts of themselves and what it means to be a man challenged. When you think about the social consequences of the war, in addition to proliferation of guns and weapons, there are these dueling challenges of this sort of militarized hyper masculinity and emasculation.   

How do we see this play out in young boys who witness extreme violence or grow up in the middle of conflict? 

In the West Bank, there is trauma in being repeatedly humiliated and being treated like a terrorist. There’s a heavy mental weight to being a kid and being forced to cross checkpoints just to get to school or the grocery store, or for the family to have to seek permission in order to visit family elsewhere. These kids are growing up under a tremendous amount of tension. The children in Gaza are living with trauma on top of trauma and we know those circumstances increase your risks of mental, behavioral, and physical health risks dramatically. They are trapped in an unsafe place and cannot get out.   

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