CAMBRIDGE: Leaders from the G8 countries left Cologne without agreeing on institutional reform for the world's financial system. Before they begin to tinker they should ponder the following scenario.
Financial market deregulation in an un-named country sets off a credit boom and an explosion in equity and real estate prices. Private sector debt, increasingly short-term, shoots up from 85% of GDP to 135% within five years. As the currency appreciates in real terms, exports falter and the current account deficit widens, and the government balks at devaluation.
Soon, devaluation in a nearby country reveals how vulnerable the economy is to the loss of international confidence. Suddenly, foreign creditors curtail short-term credit lines. The central bank tries to hold the exchange rate, but eventually is forced to let the currency float. The result is a currency collapse and a wave of bankruptcies. The economy confronts its most severe economic crisis in many decades.
Is the country Mexico in 1994-1995? Thailand or South Korea in 1997-1998? Actually, no. The country in question is Sweden in 1992-1993.