The East Asian Crisis - Macroeconomic Developments and Policy LessonsWP/98/128-EAWP/98/128 The East Asian Crisis: Macroeconomic Developments and Policy Lessons Kalpana Kochhar, Prakash Loungani, and Mark R. Stone This paper reviews macroeconomic developments during the first year of the crisis in east Asia and draws some preliminary policy lessons. The crisis is rooted in the interaction of bank-intermediated capital inflows and weaknesses in private- and public-sector governance. Investment, while high, shifted recently to low-profit nontradable projects, in part, reflecting rigid exchange rate policies and incipient structural weaknesses. The crisis was triggered by external shocks, especially exchange rate shifts and terms of trade declines, but was then spread throughout the region by the shared vulnerability to the external shocks, trade and capital linkages, and investor herding behavior. The paper contains a description of the key features of Fund programs and their rapid evolution during the past year. Macroeconomic adjustment has resulted in some surprising outcomes. The unexpectedly severe contractions of GDP reflect a collapse in domestic demand, owing to the wealth shock associated with plummeting asset prices and exchange rates. Inflation has been muted, despite the sharp depreciations. External adjustment, driven by import compression, has taken place remarkably fast. The restructuring of the corporate and financial sectors, however, is only just beginning. Some lessons for crisis resolution can be drawn at this early stage. Tight monetary policy is needed early on, but interest rates can be reduced once the exchange rate stabilizes. Fiscal policy should be flexible to strengthen the social safety net and accommodate the costs of financial sector restructuring, subject to financing constraints. Bank and corporate reforms are needed to restore viability while at the same time improve incentives for profit maximization. The experience to date also offers lessons for crisis prevention. Prudent macroeconomic policies and an outward orientation are essential. Proper bank supervision and data transparency are imperative. Strong governance is needed to ensure the free play of market forces. Capital account liberalization requires a healthy domestic financial sector and external debt must be managed prudently. Finally, crises are prevented by pragmatic policymaking that recognizes and addresses problems early, even when the going is good. |