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

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  • Edison, Hali J
  • Luangaram, Pongsak
  • Miller, Marcus

Abstract

Credit market imperfections have been blamed for the depth and persistence of the Great Depression in the US. 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 Kiyotaki and Moore’s (1997) model of highly levered credit-constrained firms 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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1866.

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Date of creation: Apr 1998
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Handle: RePEc:cpr:ceprdp:1866

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Keywords: asset price bubbles; Credit Market Imperfections; Financial Crisis; illiquidity and insolvency;

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  1. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
  2. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," NBER Working Papers 5146, National Bureau of Economic Research, Inc.
  3. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
  4. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
  5. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  6. Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, vol. 110(460), pages 236-55, January.
  7. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, December.
  8. King, Mervyn, 1994. "Debt deflation: Theory and evidence," European Economic Review, Elsevier, vol. 38(3-4), pages 419-445, April.
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