The role of external shocks in the Asian financial crisis

Within a few months in late 1997, a number of East Asian countries were hit by financial and exchange rate crises. Much analysis of this episode has emphasized either internal financial weaknesses or a process of contagion that converted a financial problem in one country into a regionwide crisis. The author of this article explores an alternative possibility: that some external shock common to all these countries triggered the crisis. The Chinese devaluation of 1994 and the prolonged Japanese recession are sometimes cited as factors, but the article concludes that they were probably only minor contributors. Evidence does suggest that the sharp rise in the value of the dollar that began about two years before the crisis itself may have had a major impact. ; The rising dollar induced substantial exchange rate appreciation for the crisis countries because, as estimates of basket weights indicate, they were tying their currencies closely to the dollar by giving the dollar heavy weight. The result was significant slowdowns in export growth that probably contributed to the regionwide crisis. The author suggests that for the future these countries might find it advantageous to peg their exchange rates to a diversified basket of currencies that would help ensure that their exports to their three largest developed-country customers-the United States, Japan, and the euro area-would not all drop off simultaneously.