International Financial Crises
What happened in Asia?
Globalization, 17.195
R. Bonoan & J. Shapiro
November 21, 1999
Government policies toward
the financial system
• Bank-centered financial system
• Weak bank supervision
• Moral hazard (Banks used as
instrument of public policy and too
big to fail)
Causes of foreign capital inflow
• Expansionary monetary policy in money centers
• Excess world liquidity (world capital glut)
• Financial deregulation
• Higher interest rates relative to money centers
• Liberalization of capital account
• Fixed exchange rate
• Loose fiscal policy
(persistent budget deficits)
Macroeconomic
vulnerability
Misallocation of capital
• Overinvestment
• Asset price bubble
• Corruption
Government
macroeconomic policy
• High relative inflation caused
by expansion of money supply
Inflow of foreign capital
• Real exchange-rate
appreciation
• Widening of current account
deficit
Government
policies toward
foreign capital
• Capital account
liberalization biased
toward short-term
capital
Debt Maturity
Structure
Triggers
• Accumulation of shortterm debt denominated in
foreign currency
• Depletion of foreign
exchange reserves
• Economic
vulnerabilities
revealed
• Foreign capital used
to finance public debt
Financial
vulnerability
• Credibility of fixed
exchange rate
undermined
• To banking crisis
• To public debt crisis
International Financial Crises
1. Vulnerabilities & Triggers
Triggers
Crisis
• Economic
vulnerabilities
revealed
• Speculative attack on
currency
• Credibility of fixed
exchange rate
undermined
• Spectre of public debt
default
• Capital outflow
2. International Financial Crises
Government Response and Feedback Mechanisms
Depletion of foreign
exchange reserves
• Credibility of fixed
exchange rate further
undermined
Crisis
• Speculative attack on currency
Exchange rate peg
under pressure
• Capital outflow
•Macroeconomic imbalances
• Spectre of public debt default
•Competitive devaluation
Financial system further
weakened
• High interest rates force borrowers
into default
• Specter of bank bailout
• Credibility of fixed exchange rate
further undermined
Incentives to devalue
increase
• Credibility of fixed exchange
rate further undermined
Domestic economy
weakens
Government
raises domestic
interest rates
• Bankruptcies/bank
collapses
• Increasing unemployment
• Rising political unrest
Government policies toward
financial system
• Bank-centered financial system
• Weak bank supervision
• Moral hazard (Banks used as
instrument of public policy and too
big to fail)
Causes of foreign capital inflow
• Expansionary monetary policy in money
centers (US, Europe, and Japan)
• Excess world liquidity (yen bubble)
• Financial deregulation in Europe
• Higher interest rates in Asian countries
relative to money centers
• Asian countries liberalize capital
accounts
Misallocation of capital
• Overinvestment
• Asset price bubble (real estate)
Inflow of foreign capital
• Corruption
Financial
vulnerability
• To banking crisis
• Public debt crisis
Triggers
The Asian Financial Crisis
3. “Crony Capitalism”
• Economic vulnerabilities
revealed (bank collapses;
corruption exposed)
• Credibility of fixed
exchange rate undermined
Crisis
• Speculative attack on
currency
• Capital outflow
“Crony Capitalism”
Bank credit to the private sector, 1981-1997
Annual rate of
expansion (in percent)
Indonesia
Thailand
South Korea
Malaysia
Philippines
Singapore
Hong Kong
Taiwan
As a percentage
of GDP
1981-1989
1990-1997
1997
22
15
13
11
-5
10
13
15
19
18
12
16
18
12
8
13
57
105
64
95
52
97
157
138
(reproduced from Eicheng reen (1999))
Causes of foreign capital inflow
• Expansionary monetary policy in money
centers (US, Europe, and Japan)
• Excess world liquidity (yen bubble)
• Financial deregulation in Europe
• Higher interest rates in Asian countries
relative to money centers
• Asian countries liberalize capital
accounts
Inflow of foreign capital
Government policies
toward foreign capital
• Capital account
liberalization biased toward
short-term capital
Debt Maturity
Structure
• Accumulation of shortterm debt denominated in
foreign currency
Financial vulnerability
• To banking crisis
The Asian Financial Crisis
4. Short-term Capital Flows
(South Korea)
Triggers
• Economic vulnerabilities
revealed (collapse of
chaebol; revelation of true
short-term debt burden)
• Credibility of fixed
exchange rate undermined
Crisis
• Speculative attack on
currency
• Capital outflow
Short-term Capital Flows
Short-term debt, second quarter of 1997
Short-term debt
Total reserves
(billions of US dollars)
Indonesia
South Korea
Malaysia
Philippines
Singapore
Taiwan
Thailand
34.25
67.51
11.18
7.74
175.23
18.87
45.57
20.34
34.07
26.59
9.78
80.66
90.02
31.36
Short-term debt ratio
(as a percentage of
total reserves)
168
198
42
79
217
21
145
(reproduced from Eichengreen (1999))
Causes of foreign capital inflow
• Expansionary monetary policy in money
centers (US, Europe, and Japan)
• Excess world liquidity (yen bubble)
• Financial deregulation in Europe
Government macroeconomic
policy
• Fixed exchange rate (dollar peg)
• Higher interest rates in Asian countries
relative to money centers
• Asian countries liberalize capital
accounts
Macroeconomic vulnerability
Inflow of
foreign
capital
• High relative inflation caused by expansion
of domestic money supply
• Real exchange-rate appreciation (also
because dollar strengthening)
• Widening of current account deficit
Triggers
• Depletion of foreign exchange reserves
•Economic vulnerabilities revealed (real
estate bubble bursts and Bangkok Bank
of Commerce fails)
• Credibility of fixed exchange rate
undermined
The Asian Financial Crisis
5. Macroeconomic Fundamentals
(Thailand)
Crisis
• Speculative attack on currency
• Capital outflow
Macroeconomic Fundamentals
Real exchange rate appreciation and current account deficits
Indonesia
South Korea
Malaysia
Philippines
Thailand
Real exchange
rate appreciation (%)
1990-1997
25
12
28
47
25
Current account balance
(as a percentage of GDP)
1990-95
1996
1997
-2.5
-3.7
-2.9
-1.2
-4.8
-1.9
-5.9
-4.9
-5.1
-3.8
-4.7
-5.2
-6.7
-7.9
-2.0
(reproduced from Eicheng reen (1999))
Conclusions
• Multiple variables to consider
• Variance across countries
– Not all factors were present in all countries
• Triggers were important
– Vulnerabilities not sufficient to cause crisis
• Several paths to crisis
– Was the crisis inevitable?
– How much weight should be assigned to each path?