Financial Crisis and Recovery: Patterns of Adjustment in East Asia, 1996-99

Abstract

This paper analyzes the macroeconomic adjustment from the crisis in East Asia in a broad international perspective. The stylized pattern from the previous 160 currency crisis episodes over the period from 1970 to 1995 shows a V-type adjustment of real GDP growth in the years prior to and following a crisis. The adjustment shows a much sharper V-type in the crisis episodes with the IMF program, compared to those without. Cross-country regressions show that depreciation of real exchange rate, expansionary macroeconomic policies and favorable global environments are critical for the speedy post-crisis recovery. In this sense, the East Asian process of adjustment is not much different from the stylized pattern from the previous currency crisis episodes. However, the degree of initial contraction and following recovery has been far greater in East Asia than what the cross-country evidence predicts. This paper argues that the sharper adjustment pattern in East Asia is attributable to the severe liquidity crisis that was triggered by investor panic and then amplified by weak corporate and bank balance sheets. We find no evidence for a direct impact of a currency crisis on long-run growth. Korea has stood out as a better performer than the other crisis countries in managing recovery largely because it has been relatively more successful in restoring the soundness and stability of its financial system.