Saturday, September 22, 2012
Misdiagnosing the Eurozone crisis: Perspectives from Asia
September 22, 2012
The Asian financial crisis of the late 1990s shows what can happen when economists misdiagnose a crisis. This column argues the Eurozone crisis may have been made worse by over-simplifying it as a debt crisis. The author suggests that the large institutional changes now afoot – the shift from Eurozone I to Eurozone II – are finally addressing the root causes, but they may be too little too late.
Given the raft of gloomy economic data, it is hardly appropriate to be optimistic about the prospects for the sustainability of the monetary union in Europe. But in one key area some progress is being made. The root causes of the crisis have been identified and actions are being taken to address them. This week, on 12 September 2012, a little-known German constitutional court took a huge decision and cleared the country’s participation in a new bailout fund. About a week ago, the ECB reversed an earlier decision and announced that it would serve as a lender of last resort in government bond markets.
Lesson to Europe from Asia
An important lesson to Europe from of the Asian financial crisis of 1997/1998 is that in managing a crisis it is critically important to distinguish between the symptoms/triggers and the root causes, and to focus on the latter rather than the former. Otherwise the patient may be given the wrong medicine, which could worsen the disease.
In contrast to the Latin America debt crisis, the Asian crisis had little to with unsustainably large government borrowing and current-account deficits. Several countries (e.g., Thailand and Malaysia) had relatively large current-account deficits, but these were because of large amounts of short-term capital coming into these countries. The root cause of the Asian crisis was the weaknesses of domestic banking sectors, which had recently been liberalised and encouraged to borrow from abroad. In such a crisis, the appropriate remedy would have been to inject liquidity in the economy through easier monetary and financial policies – exactly the opposite of what the IMF did, at least initially.