Fiscal Conservatism, Exchange Rate Flexibility, And the Next Generation of Debt Crises‪.‬

Despite all the invective hurled at international financial markets by critics of the "Washington Consensus," the fact is that strong healthy financial markets are essential for middle-income countries that aspire to the ranks of advanced countries. Deeper financial markets mean a better "allocation of risk, but they can also make economies more vulnerable to crises. The question is not simply how to avoid crises entirely, but how to handle the ones that do inevitably occur. When it comes to avoiding international debt crises, the single best precaution any middle-income country can take is to keep down its debt/GDP ratios, especially public debt, and especially public external debt. The second most important step is to adopt a sufficiently flexible exchange rate regime. Whereas relatively fixed exchange rates systems work well for poor developing countries that are insulated from international capital markets, they are a lightening rod for disaster for upper-middle-income and advanced countries, except perhaps for economies headed toward a currency union. Lessons from the Recent Debt Crises