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Asia's financial crisis: lessons and policy responses

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Author Info
Ramon Moreno
Gloria Pasadilla
Eli Remolona

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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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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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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  1. Frederic S. Mishkin, 1997. "The causes and propagation of financial instability : lessons for policy makers," Proceedings, Federal Reserve Bank of Kansas City, pages 55-96. [Downloadable!]
  2. Ul Haque, Nadeem & Montiel, Peter J., 1990. "How mobile is capital in developing countries?," Economics Letters, Elsevier, vol. 33(4), pages 359-362, August. [Downloadable!] (restricted)
  3. 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.
  4. 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.). [Downloadable!]
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  5. Kaminsky, Graciela & Lizondo, Saul & Reinhart, Carmen M., 1997. "Leading indicators of currency crises," Policy Research Working Paper Series 1852, The World Bank. [Downloadable!]
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  6. Bennett T. McCallum, 1992. "Specification of Policy Rules and Performance Measures in Multicountry Simulation Studies," IMF Working Papers 92/41, International Monetary Fund.
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  7. Ilan Goldfajn & Rodrigo O. Valdés, 1997. "Capital Flows and the Twin Crises : The Role of Liquidity," IMF Working Papers 97/87, International Monetary Fund.
  8. 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 Nov 3. [Downloadable!]
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  9. 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.
  10. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," Working Paper 97-16, Federal Reserve Bank of Atlanta. [Downloadable!]
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  11. Bernanke, Ben & Gertler, Mark, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Working Papers 95-15, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
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  12. 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.). [Downloadable!]
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  13. Nadeem Ul Haque & Peter Montiel, 1990. "Capital Mobility in Developing Countries - Some Empirical Tests," IMF Working Papers 90/117, International Monetary Fund.
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  14. Ramon Moreno, 1997. "Dealing with currency speculation in the Asian Pacific Basin," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue Apr 11. [Downloadable!]
  15. Guillermo Calvo & Carmen Reinhart & Leonardo Leiderman, 1993. "The Capital Inflows Problem: Concepts and Issues," IMF Policy Discussion Papers 93/10, International Monetary Fund.
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  16. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Azman-Saini, W.N.W. & Habibullah, M.S. & Law, Siong Hook & Dayang-Afizzah, A.M., 2006. "Stock prices, exchange rates and causality in Malaysia: a note," MPRA Paper 656, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  2. 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. [Downloadable!]
  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 Stephen M. Ross Business School. [Downloadable!]
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