Ethos Issue 3, Oct 2007

Asia After the Crisis: What Now, What’s Next?
Interview with Timothy F. Geithner

Timothy F. Geithner, President and CEO of Federal Reserve Bank of New York, discusses monetary and fiscal policy in the region a decade after the Asian Financial Crisis.

You were very much involved in trying to resolve the Asian Financial Crisis. Ten years on, with the benefit of hindsight, is there anything you would have done differently, in terms of international financial institutions and governments?
This is a hard question to answer because the right test to policy is based on what you could know then, not what you know now. Of course, it is very important to recognise that most of what made the crisis traumatic and damaging were decisions made before the crisis and the conditions that existed at that point. Those conditions gave governments very poor options. Most of what made the crisis traumatic was the size of the balancing problem and the constraints on how some policymakers could react.

One way to see this is to contrast the Malaysian experience with those of many other crisis countries—Singapore being an exception. Malaysia had been through an earlier crisis in the banking system and had largely cleaned that up. For this and other reasons, they entered that period of crisis in 1997 with a much stronger balance sheet and much less vulnerability.

Given the initial environment, it would have been very hard at the time for governments at that point to have done much to mitigate the crisis. Of course, if there had not been an election in Korea, political uncertainty in Thailand and a succession crisis in Indonesia, and if the governments had, at that point, put in place the set of policies they ultimately adopted three, six or even nine months later, the crisis might have been less damaging. But those are conditions that they probably could not have pushed for.

Given that the pre-existing conditions determined the magnitude of the crisis, could more have been done to prevent it, such as through increased surveillance and other measures by international financial institutions?
No, these conditions were essentially the consequences of choices made by governments, and I do not believe you can expect to live in a world where governments will agree to constrain their sovereignty—in a way that will give an international organisation, such as the International Monetary Fund, the mandate to influence the country’s exchange policies ahead of a crisis. It is a good idea for countries to be exposed to a system where you can have a second pair of eyes or alternative points of view and good advice to call on. But it would not be realistic to design an international surveillance regime that could make a substantial contribution to crisis prevention on this scale.

Nevertheless, Asian countries have generally learnt the right lessons in the dramatic policy moves they have made since the crisis. You could argue that the focus on foreign reserve accumulation is not the most compelling defence against crisis. In some ways, it is a reflection of market distortions and a lack of options, but you cannot but conclude that this policy has been very effective in addressing the set of initial vulnerabilities in a crisis that had been so traumatic.

It is one thing for governments to have dealt with the conditions that led to this Asian financial crisis, but are they sufficiently prepared for the next crisis to come, one that could be very different in nature?
The thing about crises is that the causes are largely unanticipated factors and the vulnerabilities are not the ones you can identify ex ante. This is a natural feature of markets. It is important to acknowledge that a lot of mature industrial countries with much more developed banking systems, financial systems, supervisory systems and government frameworks also go through periods of stress and financial crises. For some countries, such as Japan in the late 80s, or in parts of Scandinavia before that, there had been very challenging systemic financial crises even though they did not enter a period with the type of acute balancing vulnerability found in Asia.

The basic policy prescription is relatively straightforward: make sure fiscal policy is reasonably prudent; monetary policy has the flexibility and independence to address threats to price stability and sustainable growth; the banking systems have strong enough cushions; and moral hazard does not destroy incentives so that the financial system can absorb much more volatility. Overall, of course, you want an economy that is flexible enough to absorb shocks.

There are two basic options for dealing with a world with a more open capital account. One is to insulate the economy from constrained volatility. Another is to prepare to live with it more freely and comfortably. Often this is the only viable path for very open economies like what you see in Asia in general.