In his book Manias, Panics and Crashes (see the Introduction and Chapters posted on the class website) Charles Kindleberger explains the three stages of how a financial crisis develops and evolves over time. Please briefly explain these stages and how the Baltic and Mexican Tequila Crises as presented in the Hill text and the class case presentation follow this economic pattern or paradigm. Solution Kindleberger says that the first stage is mania. This phase is cause by some event, for example natural disasters, and policy reform, that changes the view on the economy. Once this happens fear and irrationality take over. There is normally speculatve excess, sharp increase in interest rates, and increased uncertainty. This leads to increased panic, adverse selection, moral hazard and a decline in economic activity. Banks and other lenders decrease, or even stop, lending completely in order to maintain some form or certainty. During this phase people borrow to buy real or illiquid financial assets. However, in the next stage, panic, people try to switch all assets to money, or repay debt. This adds to the crash in the prices or commodities, houses, buildings, land, stocks, bonds, and any other market that has been effected by mania. Both of these phases could have been avoided if the money supply could be at a stablized fixed amount, or a consistant growth level. Regulation can help with stability, it can also lead to uncertainty. The banking industry has always been a challenge to regulate. All of these lead to the crash. The decline of previous phases lead to bankrptcy, financial disintermediation, bank failure, and deflation. This all happens before lowered prices are able to provide any benefit. The Baltic and Mexican Tequila Crises both dealt with inflation and decline of foreign investment. Without investors and stable money supply the economies began to fail and have increased instablity. They also witnessed how policy/economic reform added to the mania, followed by panic. I hope that helps. .

1. In his book Manias, Panics and Crashes (see the Introduction and Chapters posted on the class
website) Charles Kindleberger explains the three stages of how a financial crisis develops and
evolves over time. Please briefly explain these stages and how the Baltic and Mexican Tequila
Crises as presented in the Hill text and the class case presentation follow this economic pattern or
paradigm.
Solution
Kindleberger says that the first stage is mania. This phase is cause by some event, for example
natural disasters, and policy reform, that changes the view on the economy. Once this happens
fear and irrationality take over. There is normally speculatve excess, sharp increase in interest
rates, and increased uncertainty. This leads to increased panic, adverse selection, moral hazard
and a decline in economic activity. Banks and other lenders decrease, or even stop, lending
completely in order to maintain some form or certainty. During this phase people borrow to buy
real or illiquid financial assets. However, in the next stage, panic, people try to switch all assets
to money, or repay debt. This adds to the crash in the prices or commodities, houses, buildings,
land, stocks, bonds, and any other market that has been effected by mania. Both of these phases
could have been avoided if the money supply could be at a stablized fixed amount, or a
consistant growth level. Regulation can help with stability, it can also lead to uncertainty. The
banking industry has always been a challenge to regulate. All of these lead to the crash. The
decline of previous phases lead to bankrptcy, financial disintermediation, bank failure, and
deflation. This all happens before lowered prices are able to provide any benefit.
The Baltic and Mexican Tequila Crises both dealt with inflation and decline of foreign
investment. Without investors and stable money supply the economies began to fail and have
increased instablity. They also witnessed how policy/economic reform added to the mania,
followed by panic.
I hope that helps.