Asian Financial crises

Chapter 12 The Yen and Boom–Bust Cycle in East Asia

International Monetary Fund
Published Date:
January 2001
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One of the key determinants of the boom–bust cycle in East Asia was the sharp appreciation of the yen against the dollar between the mid-1980s and the mid-1990s, and its subsequent depreciation. Real investment and speculative financial capital in and into East Asia responded too much to the yen movements.


I would like to start by saying that the economic crisis in East Asia since 1997 has not been an “Asian” crisis, but resembles a typical domestic financial crisis with some international aspects added on.

As in a domestic banking crisis, East Asian countries borrowed heavily short term and invested long term. Investments went to domestic businesses, and to some extent, assets markets. Investment and assets markets booms were at least partially excessive. Upon seeing signs of excesses, providers of funds to the economies started withdrawing funds, turning booms into busts and delivering devastating blows to domestic financial systems. Unlike in some other currency crises, domestic macroeconomic policy was not a main driving force. Crises spread from one country to another, exhibiting the feature of self-fulfilling contagion. During the process, East Asian currencies depreciated sharply. This added to the severity of the crises by increasing the burden of foreign currency denominated debt.

Interestingly, many financial panics in the then emerging economies such as Australia, Argentina, Italy and the US in the late nineteenth & early twentieth, centuries shared such characteristics except that exchange rates were mostly fixed under the gold standard. (See, for example, Goodhart & Delargy (1988).)

In this sense, I believe that it is misleading to emphasize too much “Asian” aspects of the current crisis.


Having said that there are common elements between the East Asian economic crisis and some previous crises, I would like to turn to pointing out features specific to the East Asian crisis. As they say, all unhappy people have some special things to worry about. Needless to say, I do not intend to produce a complete set of special features of the Asian crisis.

I will point out just one such feature, i.e., the role played by medium-term fluctuations in the yen-dollar rate. Specifically, the yen appreciated sharply in the mid- to late-1980s and again in the mid-1990s. Correspondingly, Asian currencies depreciated against the yen, not just in nominal terms, but in real terms. The attached chart shows the ratio of Japanese producer price index to East Asian producer price index (Jap. PPI/Asian PPI).1 Between the mid 1980s and the late 1980s, East Asian price competitiveness went up by about fifty percent. The increased price competitiveness produced a massive relocation of production units within Asia, especially from Japan to East Asia. During the process fixed investment in Asia relative to Japan rose sharply. In fact, the chart shows that the real exchange rate, Japan’s foreign direct investment to Asia (FDI), and Asian growth (growth) are very highly correlated.2 In this sense, the movements in the yen, its appreciation between 1985 and 1995 had a decisive impact on Asian growth.

Things were OK until 1995 when the yen reversed its course and started to depreciate drastically. As can be seen from the figure, the competitive edge Asian economies had gained during the 1985-1995 period mostly disappeared by early 1997.

With hindsight, we know that the yen was overvalued in 1995, that real depreciation of the Asian currencies had to be at least partially corrected, and that real investment and associated assets markets booms in Asia were excessive.

Unfortunately, Asian and multinational firms that were carrying out investment projects, Asian and non-Asian investors and financial institutions that were providing the funds did not realize the excesses. I hasten to add that a significant portion of FDI into Asia was doing the right thing. Only those that came at the last stage and short-term speculative flows associated with these generated excesses.

In short, the sharp appreciation of the yen between 1985-1995 and its subsequent correction seem to have been one of the driving forces of the boom and bust cycle in East Asia.


The boom and bust cycle would have been less volatile had Asian investment and assets markets responded less to the yen-dollar movements, or had the appreciation of the yen in 1995 been milder. In this sense, the two bubble-like episodes are related. This suggests that market failures played a role and that one failure led to another. How we could address these failures, I am sure, will be discussed elsewhere in this conference.

Even with a bubble in the course of the yen, the Asian crisis would have been more moderate had Asian currencies been partially pegged to the yen.

The story I have told is somewhat at odds with a standard view about the linkage between Japan and East Asia. The view holds that, for example, Japan’s share in Asian exports (13.1 percent in 1996) is smaller than that of the US (19.3 percent). Hence, real exchange rates between Japan and East Asia are not as important as I have argued. My stance here has been that they have been a bit more significant. The most important component of Asian exports, electric machinery, competes worldwide with Japanese products. Moreover, the linkage I have emphasized turns on trade and exchange rate effects on investment and growth. Through this mechanism, the two regions seem to have been more closely inter-related than a linkage by exchange rate and trade alone may suggest.

Graph 1.Intereactions between Japan and East Asia

East Asia refers to Asian NIES, ASEAN, and China. The weights were determined by the shares in Japan’s foreign trade in 1990. For the growth rate series, the weights reflect GDP shares as of 1990.

In the chart, Asian growth (scale left) and FDI (scale right) are in growth rates over year earlier. The real exchange rate (scale left) is the level of an index with differences over year earlier corresponding to rates of change.


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