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Asia's financial crisis: lessons and policy responses

  • Ramon Moreno
  • Gloria Pasadilla
  • Eli Remolona

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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  1. Ilan Goldfajn & Rodrigo O. Valdés, 1997. "Capital Flows and the Twin Crises ; The Role of Liquidity," IMF Working Papers 97/87, International Monetary Fund.
  2. Calvo, Guillermo A. & Mendoza, Enrique G., 1996. "Mexico's balance-of-payments crisis: a chronicle of a death foretold," Journal of International Economics, Elsevier, vol. 41(3-4), pages 235-264, November.
  3. Graciela Laura Kaminsky, 1997. "Leading Indicators of Currency Crises," IMF Working Papers 97/79, International Monetary Fund.
  4. Reuven Glick & Michael Hutchison, 1995. "Is pegging the exchange rate a cure for inflation? East Asian experiences," Pacific Basin Working Paper Series 95-08, Federal Reserve Bank of San Francisco.
  5. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1994. "The capital inflows problem: Concepts and issues," MPRA Paper 13902, University Library of Munich, Germany.
  6. Bennett McCallum, 1992. "Specification of Policy Rules and Performance Measures in Multicountry Simulation Studies," NBER Working Papers 4233, National Bureau of Economic Research, Inc.
  7. 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.
  8. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc.
  9. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 27-48, Fall.
  10. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
  11. Ramon Moreno, 1997. "Dealing with currency speculation in the Asian Pacific Basin," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue apr11.
  12. Frederic S. Mishkin, 1997. "The causes and propagation of financial instability : lessons for policy makers," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 55-96.
  13. 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.
  14. Ul Haque, Nadeem & Montiel, Peter J., 1990. "How mobile is capital in developing countries?," Economics Letters, Elsevier, vol. 33(4), pages 359-362, August.
  15. 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.
  16. International Monetary Fund, 1990. "Capital Mobility in Developing Countries; M386Some Empirical Tests," IMF Working Papers 90/117, International Monetary Fund.
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