Korean Financial CrisisJaehyeon EomRicardo LopezAlex Sanchez

Before The CrisisBefore 1997, average growth rate was about 7% - 8% and inflation was stable at below 5%. In December 1996, the country became the second Asian member of the Organization for Economic Co-operation and Development (OECD).Inflation was stable at below 5%. Unemployment remained below 3 percent.

Chaebol & GovernmentMeans Business Family and are actually large conglomerates. The relationship was one of necessity to increase exports in the 1960s and spur economic growth.Special Favors were granted to these few large companies.The government guaranteed repayment should a company be unable to repay its foreign creditors.

Real Estate BubbleTransformations of rice paddies and green fields in southern Seoul (Gangnam) into the First modern residential district in Korea.It focused on building residential buildings, good infrastructure, and reputable schools.The former agricultural land, then worth 300 won per 3.3 square meters has become the nations most expensive area worth around 30 million won per 3.3 square meters.

Real Estate Bubble (Continued)Similarities with Japanese Real Estate BubbleBanks aggressively offered mortgages to companies and individuals at low interest ratesThe property tax rate was low while taxation of profits from the sale of real estate was high.Differences from Japanese Real Estate BubblePrivate investors are the major buyers in KoreaApartment prices rise sharply in specific areas.

Policy MisstepsKorean Won was pegged to the dollar, refusing to devalue in tandem with the devaluation of the yen.Government policy encouraged a very rapid rate of growth of real wages, in excess of the rate of growth of labor productivity.The government adopted a tight monetary policy.

Results of Monetary and Fiscal PolicyCurrent Account deficit increased from 2% of GNP in 1995 to 5% in 1996.Exports slowed from 31% to 14%.GNP declined from 10.8% to 7.8%.Foreign debt rose from $78 billion (62% of exports) to $100 billion (76% of exports).

Capital Growth

The Scopes of Crisis

Macroeconomic ViewsReal Wage Growth > Labor ProductivityKorean Interest Rate > Worlds Interest RateContinuities of High Current Account DeficitMajor ShocksSudden Capital Outflows

Real Wage Growth Rate > Labor Productivity

Korean Interest Rate > World Interest Rate

Continuities of High Current Account Deficit

Continuities of High Current Account Deficit(Continued)

Major Shocks

Sudden Capital Outflows

Policy ResponseThe government pumped money into corporations to prevent bankruptcy.

The cooperative creditors group was established to help troubled companies.

Policy Response ContinuedIncreased funding to deal with nonperforming loans (NPLs) of financial institutions. Enhanced disclosure standards and loan classification requirements. The Government asked the Japanese and US Governments for rescue support, but without success.

How did the Policy Makers Respond to AD

Fiscal PolicyReducing the Government Consumption (G )Increasing the Taxation (T ) Monetary PolicyAdopting More Tight Monetary Policy (i )

IMF to the Rescue?In late November of 1997 the government reluctantly approached the IMF for an emergency loan. The policy responses mandated by the IMF, as part of its conditionality, were mixed.

The IMF PlanRaise interest rates.

Pursue a tight monetary policy.

Increase its fiscal surplus to 1.5% of GNP through a combination of higher taxes and lower spending.

Accumulate foreign exchange reserves.

Labor Markets RecoveryPrior to the Crisis, the Korean labor market were not as flexible as they were after the crisis.Labor unions were weakened making employment adjustments easier for corporations.The reduction of labor costs helped the companies with heavy debt survive.Companies were then able to finance directly through equities.

Equity Market RecoveryThe government deregulated foreign ownership of Korean equities and simplified stock market transactions.Various types of new mutual funds were allowed.The rich credit conditions of the private sector, together with a household consumption boom following the stock market boom, led Koreas GDP to grow a spectacular 10.6 percent.

The Gold Collection Campaign

People voluntarily donated or exchange their gold to the Korean Currency.About 35 million people participated in the campaign.227 tonnes of gold were collected ($2 billion 170 million).194 tonnes of them were used to reserve foreign currency ($1 billion 820 million).

After the RecoveryPresident Dae-jung Kim announces the end of the currency crisis in December 1999.Korea repays its $19.5 billion IMF loan.In 1999, eighteen of the twenty-seven largest Chaebols had financial expenses that exceeded operating profits, and seven of those had not been profitable for three years.Korea returned to a crawling peg system in the hope of keeping a trade surplus and a foreign reserve surplus.

Economic Recovery

Lessons LearnedFiscal discipline was a very high priority for the Korean government as opposed to the counter-cyclical stabilization role of fiscal policy. The credit crunch and financial market melt-down in the immediate aftermath of the crisis rendered monetary policy extremely ineffective.It became clear that fiscal policy should play a greater counter-cyclical role in stabilizing the economy.

Fiscal Policy ChangesBefore the crisis, the government issued only a small volume of Korean treasury bonds (KTBs).KTBs interest rates were lower than the secondary market rate thereby removing incentive to buy any.After the crisis Fiscal policy became extremely expansionary.Large issuances of KTBs along with institutional reforms led to rapid development of the Treasury bond market.

Problems DomesticCorrupt government loans to mismanaged corporations.

High interest rate regime.

Workers unions had too much power.

Refusing to intervene in the foreign exchange market to prevent overvaluation of the won.

Problems InternationalMistakes were made by both borrowers (Korea), who were too eager to rely on cheap but volatile foreign short-term loans.

Lenders (banks in the rest of the world), who were initially too eager to extend them and subsequently too quick to withdraw them.

Incompatibility with independent financial policy in Korea and unregulated global capital markets.

ConclusionThe Crisis was not caused primarily by monetary or fiscal policy.It was a merging of domestic and international circumstances.Lack of regulation or impediments of short-term capital flows.

Any QuestionsLadies and Gentlemen?