Macroeconomics

1.

Problems in the banking system eroded international confidence in these

economies.

2.

Loss of confidence raised risk premiums and interest rates.

3.

Rising interest rates, together with the loss of confidence, depressed the

prices of stock and other assets.

4.

Falling asset prices reduced the value of collateral being used for bank loans.

CASE STUDY

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5.

Reduced collateral increased default rates on bank loans.

6.

Greater defaults exacerbated problems in the banking system. Now return

to step 1 to complete and continue the circle.

Some economists have used this vicious-circle argument to suggest that the

Asian crisis was a self-fulfilling prophecy: bad things happened merely because

people expected bad things to happen. Most economists, however, thought the

political corruption of the banking system was a real problem, which was then

compounded by this vicious circle of reduced confidence.

As the Asian crisis developed, the IMF and the United States tried to restore

confidence, much as they had with Mexico a few years earlier. In particular, the

IMF made loans to the Asian countries to help them through the crisis; in

exchange for these loans, it exacted promises that the governments would reform

their banking systems and eliminate crony capitalism. The IMF’s hope was that

the short-term loans and longer-term reforms would restore confidence, lower

the risk premium, and turn the vicious circle into a virtuous one. This policy

seems to have worked: the Asian economies recovered quickly from their crisis. 

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