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

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  • Hali Edison
  • Pongsak Luangaram
  • Marcus Miller

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 crisis, 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 stabilisation 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 Centre for the Study of Globalisation and Regionalisation (CSGR), University of Warwick in its series CSGR Working papers series with number 05/98.

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Date of creation: Feb 1998
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Handle: RePEc:wck:wckewp:05/98

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  1. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(2), pages 211-48, April.
  2. King, Mervyn, 1994. "Debt deflation: Theory and evidence," European Economic Review, Elsevier, Elsevier, vol. 38(3-4), pages 419-445, April.
  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. 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.
  5. Ben S. Bernanke, 1983. "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression," NBER Working Papers 1054, National Bureau of Economic Research, Inc.
  6. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, December.
  7. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
  8. Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 110(460), pages 236-55, January.
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