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Volatility and contagion in a financially integrated world : lessons from East Asia's recent experience

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  • Alba, Pedro
  • Bhattacharya, Amar
  • Claessens, Stijn
  • Ghosh, Swati
  • Hernandez, Leonardo

Abstract

The buildup of vulnerabilities in East Asia is shown here to be mainly the result of weaknesses in financial intermediation, poor corporate governance, and deficient government policies, including pro-cyclical macroeconomic policy responses to large capital inflows. Weak due diligence by external creditors, fueled partly by ample global liquidity, also played a role but global factors were more important in triggering the crises than in causing them. The crisis occurred partly because the economies lacked the institutional and regulatory structure to cope with increasingly integrated capital markets. Trouble arose from private sector decisions (by both borrowers and lenders) but governments created incentives for risky behavior and exerted little regulatory authority. Governments failed to encourage the transparency needed for the market to recognize and correct such problems as unreported mutual guarantees, insider relations, and nondisclosure of banks'and companies'true net positions. Domestic weaknesses were aggravated by poorly disciplined foreign lending. The problem was not so much overall indebtedness as the composition of debt; a buildup of short-term unhedged debt left the economics vulnerable to a sudden loss of confidence. The same factors made the crisis's economic and social impact more severe than some anticipated. The loss of confidence directly affected by private demand - both investment and consumption - which could not be offset in the short run by net external demand. The effect on corporations and financial institutions has been severe because of the high degree of leveraging and the unhedged, short-term nature of foreign liabilities, which has led to a severe liquidity crunch. Domestic recession, financial and corporate distress, liquidity constraints, and political uncertainty were self-reinforcing, leading to a severe downturn.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2008.

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Date of creation: 30 Nov 1998
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Handle: RePEc:wbk:wbrwps:2008

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Keywords: International Terrorism&Counterterrorism; Economic Theory&Research; Fiscal&Monetary Policy; Payment Systems&Infrastructure; Banks&Banking Reform; Macroeconomic Management; Banks&Banking Reform; Financial Crisis Management&Restructuring; Economic Theory&Research; Financial Intermediation;

References

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  1. Corsetti, G. & Pesenti, P. & Roubini, N., 1998. "What Caused the Asian Currency and Financial Crisis?," Papers, Banca Italia - Servizio di Studi 343, Banca Italia - Servizio di Studi.
  2. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, . "Legal Determinants of External Finance," Working Paper 19443, Harvard University OpenScholar.
  3. 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.
  4. Ronald I. McKinnon & Huw Pill, 1996. "Credible Liberalizations and International Capital Flows: The “Overborrowing Syndrome”," NBER Chapters, in: Financial Deregulation and Integration in East Asia, NBER-EASE Volume 5, pages 7-50 National Bureau of Economic Research, Inc.
  5. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  6. Marcus Miller & Lei Zhang, 1999. "Sovereign Liquidity Crisis: The Strategic Case for a Payments Standstill," CSGR Working papers series, Centre for the Study of Globalisation and Regionalisation (CSGR), University of Warwick 35/99, Centre for the Study of Globalisation and Regionalisation (CSGR), University of Warwick.
  7. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, . "Law and Finance," Working Paper 19451, Harvard University OpenScholar.
  8. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, Elsevier, vol. 40(3-5), pages 1037-1047, April.
  9. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(3), pages 401-19, June.
  10. Maurice Obstfeld, 1984. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc.
  11. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
  12. George A. Akerlof & Paul M. Romer, 1993. "Looting: The Economic Underworld of Bankruptcy for Profit," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(2), pages 1-74.
  13. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Joshua Aizenman & Nancy Marion, 1999. "Reserve Uncertainty and the Supply of International Credit," NBER Working Papers 7202, National Bureau of Economic Research, Inc.
  2. Komulainen, Tuomas, 1999. "Currency Crisis Theories – Some Explanations for the Russian Case," BOFIT Discussion Papers, Bank of Finland, Institute for Economies in Transition 1/1999, Bank of Finland, Institute for Economies in Transition.
  3. Erinç Yeldan & Wenli Li & Xinshen Diao, 1998. "Challenges and Choices in Post-Crisis East-Asia : Simulations of Investment Policy Reform in an Intertemporal,Global Model," Departmental Working Papers, Bilkent University, Department of Economics 9816, Bilkent University, Department of Economics.
  4. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "Paper Tigers? A Model of the Asian Crisis," NBER Working Papers 6783, National Bureau of Economic Research, Inc.
  5. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "What Caused the Asian Currency and Financial Crisis? Part II: The Policy Debate," NBER Working Papers 6834, National Bureau of Economic Research, Inc.
  6. 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, Elsevier, vol. 15(1), pages 80-104, January.
  7. Sarno, Lucio & Taylor, Mark P., 1999. "Moral hazard, asset price bubbles, capital flows, and the East Asian crisis:: the first tests," Journal of International Money and Finance, Elsevier, Elsevier, vol. 18(4), pages 637-657, August.
  8. 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.
  9. Komulainen, Tuomas, 2001. "Currency Crises in Emerging Markets: Capital Flows and Herding Behaviour," BOFIT Discussion Papers, Bank of Finland, Institute for Economies in Transition 10/2001, Bank of Finland, Institute for Economies in Transition.
  10. Helmut Wagner, 2001. "Implications of Globalization for Monetary Policy," IMF Working Papers 01/184, International Monetary Fund.
  11. Mark Carlson & Leonardo Hernandez, 2002. "Determinants and repercussions of the composition of capital inflows," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 717, Board of Governors of the Federal Reserve System (U.S.).
  12. Clara Garcia, 2004. "Capital Inflows, Policy Responses, and Their Ill Consequences: Thailand, Malaysia, and Indonesia in the Decade Before the Crises," Working Papers, Political Economy Research Institute, University of Massachusetts at Amherst wp81, Political Economy Research Institute, University of Massachusetts at Amherst.

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