Depreciation and recessions in East Asia

One of the striking characteristics of the recent currency crises in East Asia is the sharp reductions in output that followed depreciations. This paper draws on an earlier literature on contractionary depreciations to motivate an empirical model of the relationship between exchange rate and output fluctuations in a panel of six East Asian economies. There is evidence of a negative relationship between economic activity and the real exchange rate in East Asia. Informal examination of output fluctuations around episodes of sharp depreciation over the 1975-1996 period conveys the impression that such episodes are associated with modest expansion and contraction cycles, with output above trend before a sharp depreciation episode and below trend after it. The cyclical pattern is accentuated when the sharp depreciation episode occurs during a banking crisis. The very steep output declines that followed the 1997 sharp depreciation episodes appear to reflect a high concentration of banking crises of unprecedented severity. However, explicitly accounting for sharp depreciation episodes or banking crises does not add to the explanatory power of the benchmark model over the period 1975-1996.