Description
It describes on economic crises covering many cases over the years like East Asian crisis,Japan’s long economic slump of the 1990’s,Argentina’s recent crisis,Mexican peso crisis and also outlines the role of IMF.
Economic Crises
Macroeconomic Crises
Macroeconomic crises are a regular feature of the global economic landscape. There has been at least one major crisis every two or three years. Most of them have been in the underdeveloped world but even rich countries like Japan and the UK have been vulnerable. Each crisis has its own pecularities but common features include loose macroeconomic policy, weaknesses in the banking system and overreaction in the financial markets
Four Crises
We will look at four different crises: a) East Asian crisis b) Japan’s long economic slump of the 1990’s c) Argentina’s recent crisis d) Mexican peso crisis Of these the first is perhaps the most important especially in view of its impact on Indian policymakers and will be examined first and in the most detail.
East Asian Crisis
Background to the crisis Brief Chronology of crisis Experiences of different countries in dealing with the crisis Lessons learnt from the crisis
Why study the Asian Crisis?
Big impact on world economy including India Good illustration of the interaction between the financial system and the macroeconomy Illustrates important themes about contagion, assymetric information etc. Had a big impact on the debate about capital account convertibility in India
Background to the Crisis
East Asia was the fastest growing region in the decades before the crisis Strong export orientation especially compared to Latin American, India High rates of savings and investments Favourable demographics Good education systems
Growth rates
Image from www.economist.com
Problems in the East Asian model
Many of the countries had high current account deficits Fixed exchange rates encouraged borrowing in shortterm foreign debt at cheap international rates. This helped create financial bubbles especially in the property sector Weak financial systems with poor credit appraisal norms. Politicized lending. Little tranparency in the lending process. Lending heavily concentrated in a few areas like property and export oriented conglomerates Eg. Top 30 chaebol had debt-equity ratios of 400% in 1996
Impossible Trinity
A concept in macroeconomic theory which says that you can’t simultaneously have: 1)Fixed exchange rates 2)Free capital flows 3)Independent Monetary policy East Asian countries had first two which meant that they lacked the monetary tools to cool overheated economy in mid-90’s
Current Account Deficits
Image from www.economist.com
Start of Crisis
The crisis struck first in Thailand which had a current account deficit of 8% of GDP in 1996 Most of this debt was financed with shortterm capital flows Thailand’s debt to foreign banks rose from 29 billion dollards in 1993 to 69 billion in 1997 most of which had maturity of less than a year
Brief Chronology
May 14 1997. Speculative attacks on Thai baht. Thailand spends billions of dollars defending its currency July 2, 1997: Thailand baht is devalued July 11, 1997: Philippine peso is devalued August 14, 1997: Indonesian rupiah falls sharply October 20-23, 1997: Hong Kong stock market panic Oct 27, 1997: Panic spreads to Western stock markets November 17, 1997: Korean won collapses August 1998: Russia defaults on its debt. Causes turmoil in the international markets. Dow falls by 512 points in one day
Currencies and Stocks
Image from www.economist.com
Dealing with the Crisis
Short run problems: Foreign exchange to pay for imports, pay off foreign debt Most countries took IMF Loans, IMF conditionalities However Malaysia pursued a different path Long-run Problems: Restoring the health of the financial sector Debt overhang: Bad debts will discourage fresh lending even when it is justified. Non-performing loans: estimates of 800 billion dollars Government needs to deal with NPL as well as restructure the financial sector
IMF Strategy
Focus on investor confidence and maintaining value of the currency In favour of free capital flows The IMF provided stabilization funds in return demanded conditionalities in the form of austerity measures like cutting fiscal deficits, raising interest rates and removing capital controls Such policies were quite successful in South Korea and Thailand but critics claimed that they ignored political realities in countries like Indonesia and created too much suffering.
Malaysia and Capital Controls
A crisis creates a policy dilemma: A recession requires low interest rates and expansionary fiscal policy to boost the economy. However the economy also needs to maintain the confidence of investors and this requires high interest rates A way out of this dilemma is for a temporary capital controls which reduces capital flight. Once the economy recovers capital controls can be lifted and the strong fundamentals will hopefully prevent capital flight. One of the most controversial policies of the crisis was Malaysia’s decision to raise raise capital controls: In contrast to the IMF prescriptions:
Malaysia fixed its exchange rates Introduced controls on capital-account transactions Lowered interest rates Reflated the domestic economy
Current account balance
Image from www.economist.com
Recovery from Asian Crisis
Image from www.economist.com
Financia Restructuring(South Korea)
Probably the most successful in coping with the postcrisis. In particular Korean Asset Management Company (KAMCO) is seen as a model in how to solve problem of bad loans. It injected 129 billion dollars to buy out NPL Sought out international regulators from USA and Sweden who had dealt with earlier crises in their countries Used investments banks for securitising property assets. Helped create a secondary market in non-performing loans Reduced political pressure to lend to a small number of conglomerates. Forced chaebol to become more transparent
Debt Restructuring
Malaysia was also successful in dealing with NPL through Danaharta: the national asset management company Danaharta was given a clear mandate to minimize the burden on taxpayers while dealing with NPL Thailand was less successful. Set up asset management company only in 2001. Wasn’t given clear mandate and preferred not to sell assets but instead to restructure Similarly the Indonesian asset-management company sold relatively few loans and was also heavily politicized
Other measures
Encouraged the consolidation of the banking sector. A smaller number of healthier banks Opened up the financial sector to foreign banks Improved financial regulation with better disclosure and prudential norms Greater balance between different sectors. Much bigger role for consumer finance which in turn means that economic growth is more balanced between external and domestic sector
Lessons learned from the Asian Crisis
Macroeconomic crises don’t come out of nowhere. There were serious problems in most of the East Asian economies. However there is still the possibility that financial markets may have overreacted Importance of reserves as a buffer in cases of crisis. Major Asian economies including India now maintain much higher reserves than before. This may create its own problems Strong economic growth may mask underlying problems. Policymakers and investors should always remain vigilant Potential problems with fixed exchange rates Influential economists like Jagdeesh Bhagwati have argued that the case for globalization is weaker for capital flows than goods flows and countries should be careful about capital market liberalization Importance of financial supervision and credit-management norms Malaysian example tentatively suggests that capital controls for a brief period may be justified
The Japanese Slump: Background
The Japanese slump of the 1990’s was shaped by the historical and political background of Japanese capitalism. A major feature of the Japanese economy since the late 19th century was the dominance of industrial houses called zaibatsu and their close connection with the government. Like the German model, Japanese capitalism was heavily based on bank finance rather than capital markets. The US , during its post-war occupation, briefly attempted to destroy the power of the zaibatsu and introduce a more market-based system. However the pressure of the Cold war along with historical inertia meant that to a large extent the Japanese corporatist model survived to the present day and indeed oversaw an amazingly rapid economic recovery during the 1950’s and 1960’s.
Causes of the Slump
In the 1980’s Japan created huge current account surpluses which led to the yen strengthening sharply against the dollar in 1985-85. The Bank of Japan was worried that a stronger yen would lead to weakening exports and a recession and therefore reduced interest rates. This lead to massive boom in the stockmarkets and real estate in the late 1980’s which was finally ended when the BOJ raised interest rates in 1989. The end to the stock and property bubble put a great deal of pressure on the balance sheets of banks whose loans were often backed by property as collateral and who owned significant amounts of equity of other firms.
Slump
One of the striking features of the Japanese slump was its long duration: more than a decade. Also unlike other crises like the East Asian crisis the slump did not lead to a sharp one-off decline in GDP over a short period but rather a prolonged period of slow growth. The pattern of a prolonged crisis is seen in the non-performing loans of Japanese banks. NPL’s rose steadily during the 1990’s and reached a peak in 2001 at just above 40 trillion yen before falling in the years since. Partly as a result of the weakness of the financial sector, the Japanese economy grew at only 1.3% per annum in real terms between 1990 and 2005. Because of deflation its nominal GDP was actually lower in 2005 than in 1997. In those 8 years US nominal GDP has grown by 50% despite a brief recession early this decade.
Financial Failures
There were periodic financial failures though the government was slow to react. In 1994 there were a serious of failures among credit co-operatives as well as housing-loan corporations which lead to a public bail-out. n 1997 , the year of the Asian financial crisis, there were more failures: among long-term credit banks, a stock broker and a major regional bank. In 1998, Long-Term Credit Bank (LTCB) one of the largest banks in the world collapsed. This was the big wake-up call for Japanese policymakers who finally began to take action on issues like NPA’s and improved financial supervision.
Public Policy and the Slump
A great deal of the blame for the long duration of the slump rests on the shoulders of the Japanese policymakers. One of the most important lessons of financial crises and slumps is that the government need to move quickly to get bad loans off the books of banks so that they can start lending and stimulate economic activity. The Japanese government was very slow in reacting to this problem and it wasn’t till 2003 that they started seriously tackling bad loans.
Policy
While the Japanese government pursued a policy of deficit financing in the 90’s, because of the cronyism and corruption of the Japanese political system a lot of the money was wasted on white elephant public sector projects of little long-term utility. The decision to raise the consumption tax in 1997 has also been criticized.
The Bank of Japan has often been criticized for being excessively conservative in its monetary policy. Some economists like Paul Krugman have claimed that Japan in the 1990’s suffered from a liquidity trap where highly elastic demand for money rendered monetary policy useless though this view has been contested. The BOJ was criticized especially for its 2000 decision to raise interest rates which put an end to the economic recovery.
Role of the Private Sector
The slump also revealed weaknesses in the Japanese corporate sector which had remained hidden during the boom years but became apparent in tougher times. Corporate governance norms and weak commercial legal protection for stockholders meant that companies were able to misallocate capital without accountability and used their access to cheap capital to expand and diversify while ignoring profitability.
Private Sector
At the same time the banks which were supposed to play the primary role in allocating capital also failed because they refused to acknowledge problem debts of their clients and ran into their own problems with NPL’s. The close links between corporates and the government helped postpone necessary adjustment during the 1990’s especially because of the deficit spending boom which provided a temporarily lifeline to struggling companies. The lifetime employment system reduced the flexibility of the labour markets and delayed the reallocation of resources from less to more productive sectors.
Recovery
The belated policy responses of the late 90’s and early 2000’s eventually paid off and the Japanese economy has been growing steadily since 2002. The banking sector is in much better health with a series of nationalizations and mergers beginning since the late 90’s. By 2004 NPL’s were less than half their 2001 peak level. Corporates have also reduced their debts and are pursuing more focussed and profitable strategies. Labour markets have become more flexible both at the legal and corporate level with a greater use of contract workers. The booming Chinese economy also helped the Japanese export sector.
Argentina. Historical and Political Background
Argentina which gained independence from Spain in 1816 was one of the fastest growing economies in the latter part of the 19th century. There was an economic boom that was driven by vast, fertile agricultural land, extensive investment from the UK and immigration from various European countries. By the early 20th century Argentina had among the richest countries in the world but this era of prosperity was ended with the Great Depression which marked a long period of stagnation which reduced Argentina to a middle-income country.
Causes of the crisis
Argentina’s crisis was a classic case of the dangers of combining a fixed exchange rate with poor macroeconomic fundamentals. The fixed rate succeeded in reducing inflation but created other problems. In a classic example of the impossible trinity, a fixed exchange rates along with free capital flows meant that the Argentina did not have an independent monetary policy. This was acceptable when the economy was booming but when it slowed down there were few policy levers to stimulate the economy Argentina still suffered from a steep debt burden which required a large amount of borrowing and led to an increase in the public debt from 35% of GDP in 1994 to 64% in 2001. Much of this debt was denominated in dollars. The weakness of the Argentine political system resulted in extensive corruption and tax evasion which further strained public finances.
Causes
The fixed rate meant that imports were relatively cheap leading to a current account deficit. Furthermore exports were a relatively small percentage of the economy and where heavily concentrated in the primary sector. The Argentine economy suffered from contagion effects from crises in other big Latin American countries like Mexico and Brazil as well as the 1998 Russian default. Because their currency was pegged to the dollar their exports also suffered when the dollar stared rising As a result of all these factors there was a steep recession in 1999 with GDP falling by 4%. This led to a loss of confidence among investors and capital flight
Events of the Crisis
The recession and loss of confidence led to a run on the banking system as panicky Argentines withdrew money from their bank accounts. By the end of 2001 more than 20 billion dollars had left the country. The government reacted by freezing bank accounts which lead a suspension of IMF aid. This lead to street protests and a collapse of the government of Fernando de la Rua in December 2001. In 2002 the new government devalued the peso and initiated a series of policy measures. The most significant was the devaluation and free float of the peso which fell from a par to the dollar to 3.9 pesos to the dollar. This helped boost exports which were also helped by a global boom in demand for agricultural products. On the downside the devaluation made imports more expensive and stoked inflation. This caused a great deal of hardship in the short run as inflation rose to 80%
Recovery from Crisis
The Argentine economy has recovered sharply from the crisis with average growth of 9% in the three years from 2003-2005. A major reason for the recovery was the successful restructuring of Argentina’s massive debt burden by the Argentine government. This process began with a default of $81 billion of debt in December 2001. This was followed by a massive debt swap where 152 types of bonds were exchanged into three issues. The bottom line was that while Argentina’s debt still remained fairly high at around 75% of GDP, its annual interest payments were considerably reduced and the maturity of the bonds increased to 42 years. The second factor which helped the recovery were strong exports particularly in the soya market where demand from China surged. Export taxes on soya exports also helped bolster public finances
Role of IMF
Finally Argentina also received two loans totalling $23 billion in 2001 which provided valuable emergency finance at the height of the crisis. However the role of the IMF in the crisis has been controversial with some critics accusing it of being too lenient on Argentina when it came to fiscal targets. The Argentine loans were as much as 15 % of the IMF’s portfolio and the bank was criticized for being so heavily exposed to an insolvent country. It should be noted that the Argentine government frequently ignored IMF advice: for instance on export taxes.
Conclusion
Like the East Asian crisis the causes of the Argentine crisis are easily understood using orthodox economic theory: essentially it is a warning about the dangers of combining fixed exchange rates with loose fiscal policies. However the Argentine recovery is a challenge to orthodoxy and suggests that unorthodox methods like debt defaults and export taxes may be useful in certain situations.
Mexican Crisis
The Mexican crisis of 1995 illustrates the classic problem of maintaining a fixed exchange rates within the context of loose macroeconomic policies. It shows how political and economic factors can interact to create a crisis It also illustrates the effectiveness of a strategy of rapid response both from the IMF and the US government
Background to the Mexican Crisis
Like the Argentine and East Asian economies, the Mexican economy was enjoying a prolonged boom before the crisis. However the booming economy hid structural problems including a current account deficit of 7% of GDP. This deficit was financed by short-term dollardenominated debt: the tesobonos
Events of 1994
The political and economic situation continued to deteriorate in 1994. There was a major peasant rebellion in Chiapas along with the assasination of the Presidential candidate of the ruling party In the run-up to the election the government loosened fiscal policy which hurt the credibility of the government in the financial markets As a result the Mexico was no longer able to finance its current account deficits through external finance
Devaluation
As a result of the pressures of financing the current-account deficit the Mexican government devalued the peso by 15% However this was widely viewed as insufficient and generated further pressure on the peso The Mexican government also undermined credibility because certain business leaders were consulted about the devaluation which allowed them to benefit at the cost of outside parties
Crisis
The devaluation was followed by a complete loss of confidence in the peso. The peso fell to half its pre-crisis value As a result inflation increased sharply and the government was forced to raise interest rates to 80% This lead to a sharp recession with GDP falling by 7% in 1995
Policy Response
The Mexican crisis is notable for the rapidity and size of the response by the US government and international bodies. This was because of the geographical proximity of Mexico to the US as well as worries that a prolonged crisis would create contagion effects around the world. The total package including loan guarantees and currency swaps was almost 50 billion dollars and the main contributors were the US government, the IMF and the BIS The aid package was highly successful and the Mexican economy grew in 1996 and Mexico was able to repay its loans in advance
Lessons from 4 Crises
Despite differences in the countries and the four crises there are certain common themes that emerge. The financial sector is crucial for economic health. All four crises exposed the weakness of the financial sector in the countries. The post-crisis also revealed the crucial importance of cleaning up bad loans quickly so that banks could stimulate investment. Countries which acted quickly like Malaysia recovered much faster than those like Japan which were slow.
Lessons
Except in Japan the crises reveal the risks of a fixed exchange rates combined with loose macroeconomic policy. While poor government policy was reponsible for all four crises, the financial markets also played a role with contagion and herding effects that went beyond economic fundamentals. The Malaysian and Argentinian crises also suggest that unorthodox measures like capital controls might be a legitimate policy tool in a crisis.
doc_742746352.ppt
It describes on economic crises covering many cases over the years like East Asian crisis,Japan’s long economic slump of the 1990’s,Argentina’s recent crisis,Mexican peso crisis and also outlines the role of IMF.
Economic Crises
Macroeconomic Crises
Macroeconomic crises are a regular feature of the global economic landscape. There has been at least one major crisis every two or three years. Most of them have been in the underdeveloped world but even rich countries like Japan and the UK have been vulnerable. Each crisis has its own pecularities but common features include loose macroeconomic policy, weaknesses in the banking system and overreaction in the financial markets
Four Crises
We will look at four different crises: a) East Asian crisis b) Japan’s long economic slump of the 1990’s c) Argentina’s recent crisis d) Mexican peso crisis Of these the first is perhaps the most important especially in view of its impact on Indian policymakers and will be examined first and in the most detail.
East Asian Crisis
Background to the crisis Brief Chronology of crisis Experiences of different countries in dealing with the crisis Lessons learnt from the crisis
Why study the Asian Crisis?
Big impact on world economy including India Good illustration of the interaction between the financial system and the macroeconomy Illustrates important themes about contagion, assymetric information etc. Had a big impact on the debate about capital account convertibility in India
Background to the Crisis
East Asia was the fastest growing region in the decades before the crisis Strong export orientation especially compared to Latin American, India High rates of savings and investments Favourable demographics Good education systems
Growth rates
Image from www.economist.com
Problems in the East Asian model
Many of the countries had high current account deficits Fixed exchange rates encouraged borrowing in shortterm foreign debt at cheap international rates. This helped create financial bubbles especially in the property sector Weak financial systems with poor credit appraisal norms. Politicized lending. Little tranparency in the lending process. Lending heavily concentrated in a few areas like property and export oriented conglomerates Eg. Top 30 chaebol had debt-equity ratios of 400% in 1996
Impossible Trinity
A concept in macroeconomic theory which says that you can’t simultaneously have: 1)Fixed exchange rates 2)Free capital flows 3)Independent Monetary policy East Asian countries had first two which meant that they lacked the monetary tools to cool overheated economy in mid-90’s
Current Account Deficits
Image from www.economist.com
Start of Crisis
The crisis struck first in Thailand which had a current account deficit of 8% of GDP in 1996 Most of this debt was financed with shortterm capital flows Thailand’s debt to foreign banks rose from 29 billion dollards in 1993 to 69 billion in 1997 most of which had maturity of less than a year
Brief Chronology
May 14 1997. Speculative attacks on Thai baht. Thailand spends billions of dollars defending its currency July 2, 1997: Thailand baht is devalued July 11, 1997: Philippine peso is devalued August 14, 1997: Indonesian rupiah falls sharply October 20-23, 1997: Hong Kong stock market panic Oct 27, 1997: Panic spreads to Western stock markets November 17, 1997: Korean won collapses August 1998: Russia defaults on its debt. Causes turmoil in the international markets. Dow falls by 512 points in one day
Currencies and Stocks
Image from www.economist.com
Dealing with the Crisis
Short run problems: Foreign exchange to pay for imports, pay off foreign debt Most countries took IMF Loans, IMF conditionalities However Malaysia pursued a different path Long-run Problems: Restoring the health of the financial sector Debt overhang: Bad debts will discourage fresh lending even when it is justified. Non-performing loans: estimates of 800 billion dollars Government needs to deal with NPL as well as restructure the financial sector
IMF Strategy
Focus on investor confidence and maintaining value of the currency In favour of free capital flows The IMF provided stabilization funds in return demanded conditionalities in the form of austerity measures like cutting fiscal deficits, raising interest rates and removing capital controls Such policies were quite successful in South Korea and Thailand but critics claimed that they ignored political realities in countries like Indonesia and created too much suffering.
Malaysia and Capital Controls
A crisis creates a policy dilemma: A recession requires low interest rates and expansionary fiscal policy to boost the economy. However the economy also needs to maintain the confidence of investors and this requires high interest rates A way out of this dilemma is for a temporary capital controls which reduces capital flight. Once the economy recovers capital controls can be lifted and the strong fundamentals will hopefully prevent capital flight. One of the most controversial policies of the crisis was Malaysia’s decision to raise raise capital controls: In contrast to the IMF prescriptions:
Malaysia fixed its exchange rates Introduced controls on capital-account transactions Lowered interest rates Reflated the domestic economy
Current account balance
Image from www.economist.com
Recovery from Asian Crisis
Image from www.economist.com
Financia Restructuring(South Korea)
Probably the most successful in coping with the postcrisis. In particular Korean Asset Management Company (KAMCO) is seen as a model in how to solve problem of bad loans. It injected 129 billion dollars to buy out NPL Sought out international regulators from USA and Sweden who had dealt with earlier crises in their countries Used investments banks for securitising property assets. Helped create a secondary market in non-performing loans Reduced political pressure to lend to a small number of conglomerates. Forced chaebol to become more transparent
Debt Restructuring
Malaysia was also successful in dealing with NPL through Danaharta: the national asset management company Danaharta was given a clear mandate to minimize the burden on taxpayers while dealing with NPL Thailand was less successful. Set up asset management company only in 2001. Wasn’t given clear mandate and preferred not to sell assets but instead to restructure Similarly the Indonesian asset-management company sold relatively few loans and was also heavily politicized
Other measures
Encouraged the consolidation of the banking sector. A smaller number of healthier banks Opened up the financial sector to foreign banks Improved financial regulation with better disclosure and prudential norms Greater balance between different sectors. Much bigger role for consumer finance which in turn means that economic growth is more balanced between external and domestic sector
Lessons learned from the Asian Crisis
Macroeconomic crises don’t come out of nowhere. There were serious problems in most of the East Asian economies. However there is still the possibility that financial markets may have overreacted Importance of reserves as a buffer in cases of crisis. Major Asian economies including India now maintain much higher reserves than before. This may create its own problems Strong economic growth may mask underlying problems. Policymakers and investors should always remain vigilant Potential problems with fixed exchange rates Influential economists like Jagdeesh Bhagwati have argued that the case for globalization is weaker for capital flows than goods flows and countries should be careful about capital market liberalization Importance of financial supervision and credit-management norms Malaysian example tentatively suggests that capital controls for a brief period may be justified
The Japanese Slump: Background
The Japanese slump of the 1990’s was shaped by the historical and political background of Japanese capitalism. A major feature of the Japanese economy since the late 19th century was the dominance of industrial houses called zaibatsu and their close connection with the government. Like the German model, Japanese capitalism was heavily based on bank finance rather than capital markets. The US , during its post-war occupation, briefly attempted to destroy the power of the zaibatsu and introduce a more market-based system. However the pressure of the Cold war along with historical inertia meant that to a large extent the Japanese corporatist model survived to the present day and indeed oversaw an amazingly rapid economic recovery during the 1950’s and 1960’s.
Causes of the Slump
In the 1980’s Japan created huge current account surpluses which led to the yen strengthening sharply against the dollar in 1985-85. The Bank of Japan was worried that a stronger yen would lead to weakening exports and a recession and therefore reduced interest rates. This lead to massive boom in the stockmarkets and real estate in the late 1980’s which was finally ended when the BOJ raised interest rates in 1989. The end to the stock and property bubble put a great deal of pressure on the balance sheets of banks whose loans were often backed by property as collateral and who owned significant amounts of equity of other firms.
Slump
One of the striking features of the Japanese slump was its long duration: more than a decade. Also unlike other crises like the East Asian crisis the slump did not lead to a sharp one-off decline in GDP over a short period but rather a prolonged period of slow growth. The pattern of a prolonged crisis is seen in the non-performing loans of Japanese banks. NPL’s rose steadily during the 1990’s and reached a peak in 2001 at just above 40 trillion yen before falling in the years since. Partly as a result of the weakness of the financial sector, the Japanese economy grew at only 1.3% per annum in real terms between 1990 and 2005. Because of deflation its nominal GDP was actually lower in 2005 than in 1997. In those 8 years US nominal GDP has grown by 50% despite a brief recession early this decade.
Financial Failures
There were periodic financial failures though the government was slow to react. In 1994 there were a serious of failures among credit co-operatives as well as housing-loan corporations which lead to a public bail-out. n 1997 , the year of the Asian financial crisis, there were more failures: among long-term credit banks, a stock broker and a major regional bank. In 1998, Long-Term Credit Bank (LTCB) one of the largest banks in the world collapsed. This was the big wake-up call for Japanese policymakers who finally began to take action on issues like NPA’s and improved financial supervision.
Public Policy and the Slump
A great deal of the blame for the long duration of the slump rests on the shoulders of the Japanese policymakers. One of the most important lessons of financial crises and slumps is that the government need to move quickly to get bad loans off the books of banks so that they can start lending and stimulate economic activity. The Japanese government was very slow in reacting to this problem and it wasn’t till 2003 that they started seriously tackling bad loans.
Policy
While the Japanese government pursued a policy of deficit financing in the 90’s, because of the cronyism and corruption of the Japanese political system a lot of the money was wasted on white elephant public sector projects of little long-term utility. The decision to raise the consumption tax in 1997 has also been criticized.
The Bank of Japan has often been criticized for being excessively conservative in its monetary policy. Some economists like Paul Krugman have claimed that Japan in the 1990’s suffered from a liquidity trap where highly elastic demand for money rendered monetary policy useless though this view has been contested. The BOJ was criticized especially for its 2000 decision to raise interest rates which put an end to the economic recovery.
Role of the Private Sector
The slump also revealed weaknesses in the Japanese corporate sector which had remained hidden during the boom years but became apparent in tougher times. Corporate governance norms and weak commercial legal protection for stockholders meant that companies were able to misallocate capital without accountability and used their access to cheap capital to expand and diversify while ignoring profitability.
Private Sector
At the same time the banks which were supposed to play the primary role in allocating capital also failed because they refused to acknowledge problem debts of their clients and ran into their own problems with NPL’s. The close links between corporates and the government helped postpone necessary adjustment during the 1990’s especially because of the deficit spending boom which provided a temporarily lifeline to struggling companies. The lifetime employment system reduced the flexibility of the labour markets and delayed the reallocation of resources from less to more productive sectors.
Recovery
The belated policy responses of the late 90’s and early 2000’s eventually paid off and the Japanese economy has been growing steadily since 2002. The banking sector is in much better health with a series of nationalizations and mergers beginning since the late 90’s. By 2004 NPL’s were less than half their 2001 peak level. Corporates have also reduced their debts and are pursuing more focussed and profitable strategies. Labour markets have become more flexible both at the legal and corporate level with a greater use of contract workers. The booming Chinese economy also helped the Japanese export sector.
Argentina. Historical and Political Background
Argentina which gained independence from Spain in 1816 was one of the fastest growing economies in the latter part of the 19th century. There was an economic boom that was driven by vast, fertile agricultural land, extensive investment from the UK and immigration from various European countries. By the early 20th century Argentina had among the richest countries in the world but this era of prosperity was ended with the Great Depression which marked a long period of stagnation which reduced Argentina to a middle-income country.
Causes of the crisis
Argentina’s crisis was a classic case of the dangers of combining a fixed exchange rate with poor macroeconomic fundamentals. The fixed rate succeeded in reducing inflation but created other problems. In a classic example of the impossible trinity, a fixed exchange rates along with free capital flows meant that the Argentina did not have an independent monetary policy. This was acceptable when the economy was booming but when it slowed down there were few policy levers to stimulate the economy Argentina still suffered from a steep debt burden which required a large amount of borrowing and led to an increase in the public debt from 35% of GDP in 1994 to 64% in 2001. Much of this debt was denominated in dollars. The weakness of the Argentine political system resulted in extensive corruption and tax evasion which further strained public finances.
Causes
The fixed rate meant that imports were relatively cheap leading to a current account deficit. Furthermore exports were a relatively small percentage of the economy and where heavily concentrated in the primary sector. The Argentine economy suffered from contagion effects from crises in other big Latin American countries like Mexico and Brazil as well as the 1998 Russian default. Because their currency was pegged to the dollar their exports also suffered when the dollar stared rising As a result of all these factors there was a steep recession in 1999 with GDP falling by 4%. This led to a loss of confidence among investors and capital flight
Events of the Crisis
The recession and loss of confidence led to a run on the banking system as panicky Argentines withdrew money from their bank accounts. By the end of 2001 more than 20 billion dollars had left the country. The government reacted by freezing bank accounts which lead a suspension of IMF aid. This lead to street protests and a collapse of the government of Fernando de la Rua in December 2001. In 2002 the new government devalued the peso and initiated a series of policy measures. The most significant was the devaluation and free float of the peso which fell from a par to the dollar to 3.9 pesos to the dollar. This helped boost exports which were also helped by a global boom in demand for agricultural products. On the downside the devaluation made imports more expensive and stoked inflation. This caused a great deal of hardship in the short run as inflation rose to 80%
Recovery from Crisis
The Argentine economy has recovered sharply from the crisis with average growth of 9% in the three years from 2003-2005. A major reason for the recovery was the successful restructuring of Argentina’s massive debt burden by the Argentine government. This process began with a default of $81 billion of debt in December 2001. This was followed by a massive debt swap where 152 types of bonds were exchanged into three issues. The bottom line was that while Argentina’s debt still remained fairly high at around 75% of GDP, its annual interest payments were considerably reduced and the maturity of the bonds increased to 42 years. The second factor which helped the recovery were strong exports particularly in the soya market where demand from China surged. Export taxes on soya exports also helped bolster public finances
Role of IMF
Finally Argentina also received two loans totalling $23 billion in 2001 which provided valuable emergency finance at the height of the crisis. However the role of the IMF in the crisis has been controversial with some critics accusing it of being too lenient on Argentina when it came to fiscal targets. The Argentine loans were as much as 15 % of the IMF’s portfolio and the bank was criticized for being so heavily exposed to an insolvent country. It should be noted that the Argentine government frequently ignored IMF advice: for instance on export taxes.
Conclusion
Like the East Asian crisis the causes of the Argentine crisis are easily understood using orthodox economic theory: essentially it is a warning about the dangers of combining fixed exchange rates with loose fiscal policies. However the Argentine recovery is a challenge to orthodoxy and suggests that unorthodox methods like debt defaults and export taxes may be useful in certain situations.
Mexican Crisis
The Mexican crisis of 1995 illustrates the classic problem of maintaining a fixed exchange rates within the context of loose macroeconomic policies. It shows how political and economic factors can interact to create a crisis It also illustrates the effectiveness of a strategy of rapid response both from the IMF and the US government
Background to the Mexican Crisis
Like the Argentine and East Asian economies, the Mexican economy was enjoying a prolonged boom before the crisis. However the booming economy hid structural problems including a current account deficit of 7% of GDP. This deficit was financed by short-term dollardenominated debt: the tesobonos
Events of 1994
The political and economic situation continued to deteriorate in 1994. There was a major peasant rebellion in Chiapas along with the assasination of the Presidential candidate of the ruling party In the run-up to the election the government loosened fiscal policy which hurt the credibility of the government in the financial markets As a result the Mexico was no longer able to finance its current account deficits through external finance
Devaluation
As a result of the pressures of financing the current-account deficit the Mexican government devalued the peso by 15% However this was widely viewed as insufficient and generated further pressure on the peso The Mexican government also undermined credibility because certain business leaders were consulted about the devaluation which allowed them to benefit at the cost of outside parties
Crisis
The devaluation was followed by a complete loss of confidence in the peso. The peso fell to half its pre-crisis value As a result inflation increased sharply and the government was forced to raise interest rates to 80% This lead to a sharp recession with GDP falling by 7% in 1995
Policy Response
The Mexican crisis is notable for the rapidity and size of the response by the US government and international bodies. This was because of the geographical proximity of Mexico to the US as well as worries that a prolonged crisis would create contagion effects around the world. The total package including loan guarantees and currency swaps was almost 50 billion dollars and the main contributors were the US government, the IMF and the BIS The aid package was highly successful and the Mexican economy grew in 1996 and Mexico was able to repay its loans in advance
Lessons from 4 Crises
Despite differences in the countries and the four crises there are certain common themes that emerge. The financial sector is crucial for economic health. All four crises exposed the weakness of the financial sector in the countries. The post-crisis also revealed the crucial importance of cleaning up bad loans quickly so that banks could stimulate investment. Countries which acted quickly like Malaysia recovered much faster than those like Japan which were slow.
Lessons
Except in Japan the crises reveal the risks of a fixed exchange rates combined with loose macroeconomic policy. While poor government policy was reponsible for all four crises, the financial markets also played a role with contagion and herding effects that went beyond economic fundamentals. The Malaysian and Argentinian crises also suggest that unorthodox measures like capital controls might be a legitimate policy tool in a crisis.
doc_742746352.ppt