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Asia's financial crisis: lessons and policy responses

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  • Ramon Moreno
  • Gloria Pasadilla
  • Eli Remolona

Abstract

This paper argues that fundamental weaknesses in Asian financial systems that had been masked by rapid growth were at the root of East Asia's 1997 currency and financial crisis. These weaknesses were caused by the lack of incentives for effective risk management created by implicit or explicit government guarantees against failure. The weakness of the financial sector was accentuated by large capital inflows, which were partly encouraged by pegged exchange rates. ; Policy responses need to be designed to restore growth in an environment of macroeconomic stability in the short run, and to prevent the recurrence of crises in the long run. In the short run, the priority is to bring about the resumption of external and internal domestic credit flows, by addressing issues such as trade financing, short-term external debt financing, the recapitalization of the financial sector through foreign investment and fiscal policy. In addition, it is suggested that fiscal policy be assigned to supporting growth and the financial sector, and monetary policy to curbing inflation and stabilizing exchange rate expectations. In the long run, policies should aim to reduce the vulnerability of the financial sector by encouraging adequate risk-management through financial reform, strengthened supervision, and regulation. It is noted that greater exchange rate flexibility and the maintenance of open capital accounts may also create incentives for managing risks effectively.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Pacific Basin Working Paper Series with number 98-02.

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Date of creation: 1998
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Handle: RePEc:fip:fedfpb:98-02

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Keywords: Financial crises - Asia ; Asia ; East Asia;

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References

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  1. Reuven Glick & Ramon Moreno, 1995. "Is pegging the exchange rate a cure for inflation? East Asian experiences," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue nov3.
  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. Bennett T. McCallum, 1992. "Specification of Policy Rules and Performance Measures in Multicountry Simulation Studies," IMF Working Papers 92/41, International Monetary Fund.
  4. Ilan Goldfajn & Rodrigo O. Valdés, 1997. "Capital Flows and the Twin Crises," IMF Working Papers 97/87, International Monetary Fund.
  5. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc.
  6. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1994. "The capital inflows problem: Concepts and issues," MPRA Paper 13902, University Library of Munich, Germany.
  7. Ul Haque, Nadeem & Montiel, Peter J., 1990. "How mobile is capital in developing countries?," Economics Letters, Elsevier, vol. 33(4), pages 359-362, August.
  8. Michael P. Dooley & Donald J. Mathieson, 1992. "Exchange rate policy, international capital mobility and monetary policy instruments," Proceedings, Federal Reserve Bank of San Francisco, pages 68-95.
  9. Reinhart, Carmen & Kaminsky, Graciela & Lizondo, Saul, 1998. "Leading Indicators of Currency Crises," MPRA Paper 6981, University Library of Munich, Germany.
  10. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  11. Guillermo A. Calvo & Enrique G. Mendoza, 1996. "Mexico's balance-of-payments crisis: a chronicle of death foretold," International Finance Discussion Papers 545, Board of Governors of the Federal Reserve System (U.S.).
  12. Frederic S. Mishkin, 1997. "The causes and propagation of financial instability : lessons for policy makers," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 55-96.
  13. Ramon Moreno, 1997. "Dealing with currency speculation in the Asian Pacific Basin," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue apr11.
  14. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
  15. Ramon Moreno & Mark M. Spiegel, 1997. "Are Asian economies exempt from the "impossible trinity?": evidence from Singapore," Pacific Basin Working Paper Series 97-01, Federal Reserve Bank of San Francisco.
  16. International Monetary Fund, 1990. "Capital Mobility in Developing Countries," IMF Working Papers 90/117, International Monetary Fund.
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Citations

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Cited by:
  1. Kwack, Sung Yeung, 2000. "An empirical analysis of the factors determining the financial crisis in Asia," Journal of Asian Economics, Elsevier, vol. 11(2), pages 195-206.
  2. Cohen, Benjamin H. & Remolona, Eli M., 2008. "Information flows during the Asian crisis: Evidence from closed-end funds," Journal of International Money and Finance, Elsevier, vol. 27(4), pages 636-653, June.
  3. Jian Tong & Chenggang Xu, 2004. "Financial Sector Returns and Creditor Moral Hazard: Evidence from Indonesia, Korea, and Thailand," William Davidson Institute Working Papers Series 2004-687, William Davidson Institute at the University of Michigan.
  4. Evrensel, Ayse Y. & Kutan, Ali M., 2007. "IMF-related announcements and stock market returns: Evidence from financial and non-financial sectors in Indonesia, Korea, and Thailand," Pacific-Basin Finance Journal, Elsevier, vol. 15(1), pages 80-104, January.
  5. Carlo Castellana, 2012. "Impact of the economic crisis on the Italian public healthcare expenditure," Papers 1205.2863, arXiv.org.
  6. Joe Brocato & Kenneth Smith, 2012. "Sudden equity price declines and the flight-to-safety phenomenon: additional evidence using daily data," Journal of Economics and Finance, Springer, vol. 36(3), pages 712-727, July.
  7. W N W Azman-Saini & M S Habibullah & Siong Hook Law & A M Dayang-Affizzah, 2007. "Stock Prices, Exchange Rates and Causality in Malaysia: A Note," The IUP Journal of Financial Economics, IUP Publications, vol. 0(1), pages 7-13, March.
  8. Bank for International Settlements, 2008. "India’s financial openness and integration with Southeast Asian countries: an analytical perspective," BIS Papers chapters, in: Bank for International Settlements (ed.), Regional financial integration in Asia: present and future, volume 42, pages 181-201 Bank for International Settlements.
  9. Reuven Glick, 1998. "Thoughts on the origins of the Asia crisis: impulses and propagation mechanisms," Pacific Basin Working Paper Series 98-07, Federal Reserve Bank of San Francisco.

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