East Asian financial cycles: Asian vs. global financial crises

  It is well known that East Asia, particularly Indonesia, Korea, Malaysia and Thailand, experienced one of the worst sudden stops together with harsh output losses during the Asian Financial Crisis (AFC) in 1997-98. Despite the significant spillover effect of the Global Financial Crisis (GFC), however, East Asia appears to be least affected among peripheral economies. In fact, IMF (2012) argues that some emerging market economies including East Asia proved to be resilient against the GFC because of their policy frameworks and their policy space for monetary and fiscal stimulus.

  Against the above background, the purpose of this paper is to examine how precisely different are the role of financial channels in explaining business cycles of East Asia between these two crises. We construct a Financial Condition Index (FCI) to summarize the impact of financial shocks on business cycles in these countries. Focusing on recessions, which include economic crises such as the AFC and the GFC, we would like to know how financial some cycles are. That is, some business cycles led dominantly by financial shocks can be called financial cycles. Furthermore, we are concerned with which financial market such as credit, stock, bond, property, and foreign exchange markets plays a leading role in financial cycles. Credit supply, asset prices, interest rates and exchange rates interact with one another, of course. We try to disentangle their interdependence and to identify which financial market plays a leading role in impacting real economic activity in the four economies in the recent period.

  We will show that the AFC was a financial cycle and literally a financial crisis in that it was a recession caused predominantly by financial shocks in all the four economies in East Asia. But it is not the case for the GFC, which we will show by looking at the role of financial shocks in business cycles in East Asia since the 1990s. Among individual financial markets, the foreign exchange market and the stock market are shown to play dominant roles in generating recessions in the four countries throughout the previous two decades. Particularly, it will be suggested that the exchange rate has reflected changes in risk perception rather than in relative prices.