The East Asian Crisis: Investigating Causes and Policy Responses
58 Pages Posted: 20 Apr 2016
Date Written: August 1999
Abstract
The primary cause of the East Asian crisis was a fundamental reassessment of the profitability of investments in the region. As a policy response, temporary fiscal expansion generally appears preferable to monetary expansion or to permanent fiscal expansion.
McKibbin and Martin identify as the primary cause of the East Asian crisis a fundamental reassessment of the profitability of investments in the region.
They identify a number of secondary shocks as well, including interest risk premia, monetary expansion, and declines in output brought about by failures of the financial market.
Unlike the Latin American crisis of the 1980s, the East Asian crisis did not reflect commodity price shocks, large changes in world interest rates, fiscal imbalances, or inflationary shocks. It involved large-scale borrowing abroad, but by the private sector rather than the government - and for the normally well-regarded purpose of funding capital investment. It seems unlikely that terms of trade shocks or changes in exchange rates due to pegging to the dollar could, alone, have caused an adjustment crisis of this magnitude - although they could have helped trigger the crisis.
More important, expectations of future growth in returns to the corporate sector began to fall. Declines in asset valuations caused major shifts in investment portfolios, and the consequences of asset market shocks were compounded by secondary shocks associated with the abrupt shift to floating rates, concerns about the credibility of government policies, weaknesses in financial sectors, and inadequacies in the mechanisms for corporate restructuring and liquidation.
McKibbin and Martin use a forward-looking modeling framework to capture some of the major interactions between asset markets, output, and trade in the countries worst hit by the crisis. They find that the model is able to capture the main features of the crisis.
This paper - a product of Trade, Development Research Group - is part of a larger effort in the group to understand the links between trade and growth.
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