Lesson from Asian Crisis Essay

7359 Words Mar 30th, 2013 30 Pages
The financial crisis which began in July 1997 in the East Asian countries, Thailand, Indonesia, Malaysia and Korea, has had devastating effects on their economies. Growth rates in these countries which were in excess of five percent before 1997, turned sharply negative in 1998 and, at the time of this writing it is not yet clear when these economies will turn the corner and resume positive rates of growth. This paper examines why these countries, which were part of what has been termed

"the Asian miracle" and were able to eradicate so much poverty, are now undergoing severe economic contractions, with such harmful effects on their populations. A breakdown of information in financial markets is the key factor that has driven this
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This analysis emphasizes that the crisis was caused by fundamentals, particularly problems in the financial sector, and is thus consistent with recent work by Corsetti, Pesenti and Roubini (1998), Goldstein (1998) and Krugman (1998). However, it does not rule out that illiquidity and multiple equilibria stories of the type outlined by Radelet and Sachs (1998) played some role as well. The analysis here, however, goes beyond these other papers by focusing on the mechanisms through which the financial crisis in East Asia caused sharp contractions in economic activity. In most financial crises, and particularly in the East Asian crises, the key factor that causes asymmetric information problems to worsen and launch a financial crisis is a deterioration in balance sheets, particularly those in the financial sector. As in earlier financial crises, such as in Chile in 1982 or Mexico in 1994-95 where a similar analysis applies,1 the story starts with financial liberalization that resulted in the lending boom which was fed by capital inflows. Once restrictions were lifted on both interest-rate ceilings and the type of lending allowed, lending increased dramatically. As

documented in Corsetti, Pesenti and Roubini (1998), Goldstein (1998), World Bank (1998) and Kamin (1999), credit extensions in the Asian crisis countries grew at far higher rates than GDP. The problem with the resulting lending boom was not that lending expanded, but that it expanded so rapidly that excessive

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