Asset Bubbles, Domino Effects and 'Lifeboats' Elements of the East Asian Crisis

35 Pages Posted: 8 Aug 1998  

Hali J. Edison

International Monetary Fund (IMF) - Research Department

Pongsak Luangaram

University of Warwick - Department of Economics

Marcus H. Miller

University of Warwick - Department of Economics; Institute for International Economics; Centre for Economic Policy Research (CEPR)

Date Written: March 1998

Abstract

Credit market imperfections have been blamed for the depth and persistence of the Great Depression in the USA. Could similar mechanisms have played a role in ending the East Asian miracle? After a brief account of the nature of the recent crises, we use a model of highly levered credit-constrained firms due to Kiyotaki and Moore (1997) to explore this question. As applied to land-holding property companies, it predicts greatly amplified responses to financial shocks--like the ending of the land price bubble or the fall of the exchange rate. The initial fall in asset values is followed by the "knock-on" effects of the scramble for liquidity as companies sell land to satisfy their collateral requirements--causing land prices to fall further. This could lead to financial collapse where--like falling dominoes--prudent firms are brought down by imprudent firms.

Key to avoiding collapse is the nature of financial stabilization policy; in a crisis, temporary financing can prevent illiquidity becoming insolvency and launching "lifeboats" can do the same. But the vulnerability of financial systems like those in East Asia to short-term foreign currency exposure suggests that preventive measures are also required.

JEL Classification: F3, G1, E5

Suggested Citation

Edison, Hali J. and Luangaram, Pongsak and Miller, Marcus H., Asset Bubbles, Domino Effects and 'Lifeboats' Elements of the East Asian Crisis (March 1998). FRB International Finance Discussion Paper No. 606. Available at SSRN: https://ssrn.com/abstract=93688 or http://dx.doi.org/10.2139/ssrn.93688

Hali J. Edison (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-6946 (Phone)
202-589-6946 (Fax)

Pongsak Luangaram

University of Warwick - Department of Economics ( email )

Coventry CV4 7AL
United Kingdom

Marcus H. Miller

University of Warwick - Department of Economics ( email )

Coventry CV4 7AL
United Kingdom
+44 24 7652 3048/9 (Phone)
+44 24 7652 3032 (Fax)

Institute for International Economics

1750 Massachusetts Avenue, NW
Washington, DC 20036-1903
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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