Determinants of Banking, Inflation, and Foreign Exchange Reserves Crises: The Case of Bolivia

Abstract

Utilizing logit econometric models, this paper investigates the primary factors contributing to the onset of banking, inflation, and foreign exchange reserves crises in Bolivia. The analysis reveals that banking crises are more likely when the terms of trade improve, with greater monetary independence, greater income inequality, and higher poverty levels. Principal deterrents are a stronger economy, greater financial openness, and better health outcomes. Increases in the money supply mostly drive inflation crises, hence the principal deterrent is the Central Bank of Bolivia suppressing monetary expansion. Finally, foreign exchange reserves crises are more likely when the money supply grows, the country experiences higher levels of external and short-term debt, and as Bolivia becomes more open to financial transactions with the rest of the world. Deterrents include increasing levels of per capita income, inflation, increasing levels of total reserves, and improvements in the current account balance. The principal lesson that can be drawn from the Bolivian experience is that policymakers can act in ways that will decrease the probability of these crises happening in the first place.