Lesson from Asian Crisis

In: Business and Management

Submitted By alicelsy0530
Words 7371
Pages 30
The financial crisis which began in July 1997 in the East Asian countries, Thailand, Indonesia, Malaysia and Korea, has had devastating effects on their economies. Growth rates in these countries which were in excess of five percent before 1997, turned sharply negative in 1998 and, at the time of this writing it is not yet clear when these economies will turn the corner and resume positive rates of growth. This paper examines why these countries, which were part of what has been termed

"the Asian miracle" and were able to eradicate so much poverty, are now undergoing severe economic contractions, with such harmful effects on their populations. A breakdown of information in financial markets is the key factor that has driven this crisis. After laying out an asymmetric information view of the Asian financial crisis, this paper goes on to use this framework to explore lessons from this crisis.

1. An Asymmetric Information View of the Asian Crisis

The financial system plays a critical role in the economy because, when it operates properly, it channels funds from those who have saved surplus funds to those who need these funds to engage in productive investment opportunities. The major barrier to the financial system performing this job properly is asymmetric information, the fact that one party to a financial contract does not have the same information as the other party, which results in moral hazard and adverse selection problems. An asymmetric information view of financial crises, which I have described in more detail elsewhere in Mishkin (1996a, 1997), defines a financial crisis to be a nonlinear disruption to financial markets 1

in which the asymmetric information problems of adverse selection and moral hazard become much worse, so that financial markets are no longer able to efficiently channel funds to those who have the most productive investment…...

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