Multidimensional aspects of international financial crisis in East Asia

This paper examines the causes and effects of the 1997 East Asian financial crisis and analyzes the potential effectiveness of monetary policy in stabilizing exchange rates after a crisis occurs. A debate has erupted as to the appropriateness of tight versus easy monetary policy in stabilizing exchange rates. Some researchers have argued that a tight policy (raising interest rates) is necessary to stabilize exchange rates. Others have argued that tight monetary policy is detrimental to exchange rate stabilization. This debate remains unresolved.; This debate ensues partially because there has been little meaningful empirical research done that addresses the validity of the IMF policy model. In our research, we examine the nature of financial crisis in general and the East Asian crisis in particular. The research is presented in three parts. Part I statistically examines the key variables that triggered the East Asian financial crisis. We construct a proxy model of a crisis to isolate the causes of a crisis. We find the most pressure for a crisis comes from the external sector and the financial sector. A crisis has a higher probability of occurring when current account deficits are high, foreign interest rates increase, financial liberalization is present, the reserve ratio is low, and a lending boom is underway. We conclude that financial sector risk management capability is the most sensitive area of concern in reducing the probability and magnitude of a currency crisis. Part II discusses the macroeconomic impacts of the crisis on East Asian countries. Part III conducts an empirical analysis of the IMF policy model to determine the potential effectiveness of a tight versus easy monetary policy in stabilizing exchange rates. For the years examined, we find a tight monetary policy has the potential to be effective in stabilizing exchange rates in Thailand, Philippines, and Indonesia but was ineffective in the case of Korea and Malaysia.