The impact of the Asian crisis on the global economy, the roots of financial crises, and the prospects for an economic downturn in the United States were among the topics addressed at the annual meeting of the American Economic Association (Allied Social Science Associations), held in New York January 3–5.
At a roundtable on the lessons from the financial crisis in east Asia, senior officials from the IMF and the World Bank, together with other observers, provided their views. Michael Mussa, Director of the IMF’s Research Department, noted that the crisis was likely to drive world output 5 percent below its potential path by the end of 2000 and explained that there were four main issues:
Emerging markets should adopt better macroeconomic policies, coupled with strengthened supervision and management of financial systems, to minimize vulnerability to financial crises. These should be combined with sound policies to minimize the risks created by large inflows of private capital.
Better policy responses were needed to lessen the damage from crises, and countries should continue to resist excessive exchange market pressure.
At the systemic level, it was not enough to leave matters to the working of the market, since the market had no quick, clean solution to the problems of countries facing the potential for systemic default. The financial assistance of the international community, including the IMF, was needed, although it could not successfully resolve all crises.
The conditions that are a requirement of IMF lending help countries adopt appropriate policies and avoid future crises. In this respect, the new IMF Supplementary Reserve Facility would play an important role.
Later, in answer to questions, Mussa said that at the national level there were a variety of mechanisms that could protect countries from the consequences of crises. At the international level, however, there were too few such mechanisms.
What went wrong in Asia? Joseph Stiglitz, Chief Economist at the World Bank, asked. Ex ante, he said, the markets did not foresee any problems. The positive elements outweighed the negative. While there had been some problems in Thailand, these were minor. In Asia as a whole the miracle had worked and growth had benefited the great majority of the people. Also, according to the economic models, many countries that did not have financial crises appeared more vulnerable than those that did. Even in retrospect it was not obvious where the roots of the crises lay. The real problem was in the scale of borrowing by the private sector.
Moreover, Stiglitz said, there is a need to mitigate the consequences of crises. Most developing countries do not have the social safety nets of the more advanced countries, particularly in the informal sectors, such as agriculture. More attention should be paid to countries’ exposure to risk and the measures that need to be taken to protect them from the consequences of such risk. In the final analysis, he concluded, no country has perfect policies and the architecture of the international system should be robust enough to cope with vicissitudes.
Another perspective was provided by Rudiger Dornbusch of the Massachusetts Institute of Technology. He noted that whereas the “old-style” crisis had primarily affected the current account, the Asian crisis had to do with balance sheets, with changes in the exchange rate increasing debt burdens and the problems being compounded by bad banking systems. Owing to globalization, he said, when a crisis broke out in one country, it quickly spread to others and a small problem developed into a huge one. He argued that the solution was not for the IMF to provide more money, but early debt restructuring. In a country such as Brazil, he observed, IMF lending had checked the crisis and given time; it was now appropriate for the country to adopt a currency board. An offshore lender of last resort, he felt, was needed to take over the responsibilities of the IMF.
Edmund Phelps of Columbia University, New York, saw the solution to a “crisis of corporatism” in Asia as more capitalism. A long period of disequilibrium and overoptimistic expectations lay at the root of the collapse of some Asian economies. At the global level, he said, a new independent institution was needed to disseminate timely information to the markets, a role that an official body such as the IMF could not undertake since it might risk precipitating a new crisis.
International Financial System
In another panel, Stiglitz, Dornbusch, and other participants discussed issues of global financial markets and public policy.
In his comments, Stiglitz noted the considerable fragility in current arrangements and went on to outline some of the principles for the new international financial system. It was necessary, he said, to address the roots of current problems. One should recognize that it was hard to build sound financial institutions, even in industrial countries. Important objectives, in his view, should be to increase the stability of capital flows and to develop sound banking systems. He warned against the tendency to anthropomorphize the market and see it as a single entity. In fact, he said, there are several different markets, both within and outside a country.
There were two extreme views of the IMF, Dornbusch said. On the one hand was the view that the IMF should be transformed into a world central bank or an international lender of last resort, while, on the other, it was argued that the IMF had failed and should be abolished. Neither of these extreme positions was likely to happen, he said. Asking what went wrong in Asia, he maintained that both the content of programs and the level of assistance had been unsatisfactory. He had no problems with the normal IMF prescriptions of higher interest rates and fiscal stability in a crisis. He considered, though, that the IMF should have focused more aggressively on developing an effective debt strategy to tackle the crisis.
David M. Jones of Aubrey G. Lanston and Co., Inc. made the point that if countries were able to correct problems in their domestic economies, then everything would work out satisfactorily on the international front. He said that world markets had been close to a “meltdown” in mid-August 1998 after the Russian crisis. The effects of the global crisis had been limited by the quick actions of Alan Greenspan, the Chairman of the U.S. Federal Reserve Board, who had stepped in to stabilize markets in the wake of the near-collapse of the Long-Term Capital Management (LTCM) hedge fund. Transparency, he observed, is key for central banking success, and Greenspan and the Federal Reserve had been noticeably more transparent in their recent actions.
China and the Asian Crisis
In a panel on the issue of whether China might catch “the Asian flu,” Jeffrey Sachs of the Harvard Institute for International Development commended China on maintaining a satisfactory growth rate at a time when the economies of other Asian countries were either stagnant or contracting. At the root of the Asian crisis, he said, lay several factors, including domestic mismanagement and “crony capitalism,” compounded by a dramatic reversal of international capital flows. He did not agree with the moral hazard argument that money kept flowing into Asian countries in the expectation of a bailout. In fact, money flowed in because investors did not expect Asia to collapse; rather, they expected to make a lot of money. What really went wrong, Sachs considered, was the working of international financial markets, which created a self-fulfilling panic.
The question of the future stability of the Chinese currency, the renminbi, was considered by Gene Chang of the University of Toledo. He said that many of the conditions for a currency crisis that had affected other Asian countries did not yet exist in China. The renminbi was not convertible in the capital account, foreign financial capital could not flow freely across the border, and China could isolate its markets from outside shocks. But he saw a likelihood that the costs of continuing to peg the renminbi would increase as international and domestic conditions changed in the future. A fiscal expansion could lead to a deterioration of the Chinese current account balance, he said. Or, if the Hong Kong dollar were to depreciate, this could lead to concerns over the stability of the Hong Kong SAR economy that could lead in turn to a depreciation of the renminbi.
The experience of Korea held a number of lessons for China, in the view of Elliot Parker of the University of Nevada. These were delaying financial liberalization could be costly, effective bankruptcy legislation was necessary for economic growth, the national regulatory authorities should backstop liberalization, and greater transparency was always desirable.
Tigers and Tequilas
The similarities and differences between the Asian crisis and the Mexican crisis of 1994 were addressed by Guillermo Calvo and Carmen Reinhart of the University of Maryland in a session moderated by IMF First Deputy Managing Director Stanley Fischer.
Calvo observed that there were a number of differences between the two crises. For example, a low level of savings was one cause of the problem in Mexico, but not in the Asian countries. The impact of the Russian crisis on the markets was remarkable, he said, in that Russia rarely traded with emerging markets and its economy constituted no more than 1 percent of world GDP, yet its default affected all emerging markets. He identified a tendency for clusters of market specialists to be formed, who in their turn unduly affected Wall Street investors.
Reinhart concluded from a study of 20 developed and emerging markets that contagion was more a regional than a global phenomenon. She also observed that the susceptibility to crises was “nonlinear.” In other words, a single country falling victim to contagion was not a predictor of crisis in other countries, but when several countries fall victim the likelihood of crises elsewhere increases sharply. In the same way, often clusters of banks were formed with a common exposure. When a crisis broke out, these banks pulled out not only from those emerging markets that encountered problems but from other markets too.
In commenting on these two presentations, Maurice Obstfeld of the University of California at Berkeley agreed that there was a puzzling question why the aftermath of the Russian crisis was so severe.
John Williamson, Chief Economist in the World Bank’s South Asia Regional Office, said that contagion had been spread in Asia through countries’ exposure to the international market. It was clear, he said, that there was a need to regulate capital markets. Until this was done, countries should keep up their defenses.
In an analysis of U.S. domestic economic prospects, a panel addressed the question of how different the current economic expansion in the United States is from earlier expansionary episodes.
Mark Watson of Princeton University observed that the behavior of GDP in the current expansion appeared less volatile than during previous expansions. The current long-term bond rates indicated that output would continue to increase, as would the federal funds rate.
The current figures for inflation and unemployment were astonishing in the view of James Stock of Harvard University. Earlier, the natural rate of unemployment (NAIRU) had been estimated at 6.7 percent. Unemployment had now fallen below the low end of the NAIRU confidence interval. Philip Klein of Pennsylvania State University noted that in 1995 industrial strikes in the United States reached a 15-year low, a sign of declining union power that had resulted in more flexible labor markets.
Alan Blinder of Princeton University, a former member of the Board of Governors of the U.S. Federal Reserve System, agreed that the current expansion was different from previous ones. It was unusual that GDP growth had expanded while inflation had not, he said, adding that “if in 1997 we had forecast the actual outcomes in 1999, we would all have been laughed at and then fired.” He explained that the greater transparency of monetary policy at the Federal Reserve had helped to stabilize market volatility.
In answer to the question of how long the expansion would last, Victor Zarnowitz of the Foundation for Business and Economic Research said that normally a boom would be followed by a bust. But the bust is usually limited. For this reason, he did not forecast a severe recession even if the current expansion were to end. In any event, he concluded, one could have a strong expansion after a severe recession.
Fischer Speech Addresses Subject of I International Lender of Last Resort
IMF First Deputy Managing Director Stanley Fischer addressed a joint luncheon of the American Economic Association and the American Finance Association on January 3 on the need for a lender of last resort. A summary of his address was published in the last issue of the IMF Survey, dated January 11, pages 6-7. The full text is available on the IMF website: www.imf.org.
Photo Credits: Denio Zara, Padraic Hughes, and Pedro Marquez for the IMF.