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International Financial Crises

What happened in Asia?

Globalization, 17.195

R. Bonoan & J. Shapiro

November 21, 1999

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Government policies towardthe financial system

• Bank-centered financial system

• Weak bank supervision

• Moral hazard (Banks used asinstrument of public policy and toobig to fail)

Governmentpolicies towardforeign capital

• Capital accountliberalization biasedtoard short-termcapital

• !oreign capital usedto finance public debt

Misallocation of capital• "verinvestment• #sset price bubble

• Corruption

Financial

vulnerability• $o banking crisis

• $o public debt crisis

Debt MaturityStructure

• #ccumulation of short-term debt denominated inforeign currency

Crisis• %peculative attack oncurrency

• Capital outflo

• %pectre of public debtdefault

Governmentmacroeconomic policy

• !i&ed e&change rate

• 'oose fiscal policy(persistent budget deficits)

Macroeconomicvulnerability

• igh relative inflation causedby e&pansion of money supply

• eal e&change-rateappreciation

• Widening of current accountdeficit

Triggers• *epletion of foreigne&change reserves

• +conomicvulnerabilitiesrevealed

• Credibility of fi&ed

e&change rateundermined

Triggers • +conomicvulnerabilitiesrevealed

• Credibility of fi&ed

e&change rateundermined

International Financial Crises

1. Vulnerabilities & Triggers

Causes of foreign capital inflow• +&pansionary monetary policy in money centers• +&cess orld li,uidity (orld capital glut)• !inancial deregulation• igher interest rates relative to money centers• 'iberalization of capital account

Inflow of foreign capital

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Financial system furtherweakened

• igh interest rates force borroersinto default

• %pecter of bank bailout

• Credibility of fi&ed e&change ratefurther undermined

Domestic economywea

kens• Bankruptciesbankcollapses

• .ncreasing unemployment

• ising political unrest

Crisis

• %peculative attack on currency

• Capital outflo

• %pectre of public debt default

Incentives to devalueincrease

• Credibility of fi&ed e&changerate further undermined

2. International Financial Crises

Government Response and Feedback Mechanisms

Depletion of foreignechange reserves• Credibility of fi&ed

e&change rate furtherundermined

Governmentraises domesticinterest rates

!change rate pegun

der pressure

•Macroeconomic imbalances

•Competitive devaluation

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Government policies towardfinancial system

• Bank-centered financial system

• Weak bank supervision

• Moral hazard (Banks used asinstrument of public policy and toobig to fail)

Misallocation of capital

• "verinvestment

• #sset price bubble (real estate)

• Corruption

Financialvulnerability

• $o banking crisis

• /ublic debt crisis

Crisis

• %peculative attack oncurrency

• Capital outflo

Triggers • +conomic vulnerabilitiesrevealed (bank collapses0corruption e&posed)

• Credibility of fi&ede&change rate undermined

The Asian Financial Crisis

3. “Crony Capitalism”

Causes of foreign capital inflow• +&pansionary monetary policy in moneycenters (1%2 +urope2 and 3apan)

• +&cess orld li,uidity (yen bubble)

• !inancial deregulation in +urope

• igher interest rates in #sian countriesrelative to money centers

• #sian countries liberalize capital accounts

Inflow of foreign capital 

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“Crony Capitalism”

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Inflow of foreign capital

Government policiestoward foreign capital

• Capital accountliberalization biased toardshort-term capital

Financial vulnerability

• $o banking crisis

Debt MaturityStructure

• #ccumulation of short-term debt denominated inforeign currency

Crisis

• %peculative attack oncurrency

• Capital outflo

The Asian Financial Crisis

4. Short-term Capital Flows(South Korea)

Triggers

• +conomic vulnerabilitiesrevealed (collapse ofchaebol 0 revelation of trueshort-term debt burden)

• Credibility of fi&ed

e&change rate undermined

Causes of foreign capital inflow• +&pansionary monetary policy in moneycenters (1%2 +urope2 and 3apan)

• +&cess orld li,uidity (yen bubble)

• !inancial deregulation in +urope

• igher interest rates in #sian countriesrelative to money centers

• #sian countries liberalize capital accounts

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Short-term Capital Flows

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Crisis

• %peculative attack on currency

• Capital outflo

Government macroeconomicpolicy

• !i&ed e&change rate (dollar peg)

Macroeconomic vulnerability

• igh relative inflation caused by e&pansionof domestic money supply

• eal e&change-rate appreciation (alsobecause dollar strengthening)

• Widening of current account deficit

Triggers

• *epletion of foreign e&change reserves

•+conomic vulnerabilities revealed (realestate bubble bursts and Bangkok Bank

of Commerce fails)• Credibility of fi&ed e&change rateundermined

The Asian Financial Crisis

5. Macroeconomic Fundamentals(Thailand)

Causes of foreign capital inflow

• +&pansionary monetary policy in moneycenters (1%2 +urope2 and 3apan)

• +&cess orld li,uidity (yen bubble)

• !inancial deregulation in +urope

• igher interest rates in #sian countriesrelative to money centers

• #sian countries liberalize capital accounts

Inflow offoreign

capital

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Macroeconomic Fundamentals

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• 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?

Conclusions