Unconventional Monetary Policy

in the Asian Financial Crisis

Tamim Bayoumi and Joseph Gagnon

December 2, 2016
The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian
Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI
does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology
used may not necessarily be consistent with ADB official terms.

12/5/2016 Peterson Institute for International Economics | 1750 Massachusetts Ave., NW | Washington, DC 20036 1
 Policy in the Asian Financial Crisis

Western economists (IMF) focused on structural

flaws in Asia and necessary reforms.
Asian policymakers complained about volatile
financial markets.
They received little sympathy.
West was in thrall of efficient markets hypothesis.
UMP (QE) in recent years relies on non-
efficiency of markets.
Some actions taken in Asia crisis have QE aspects.

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 Model with Imperfect Asset Substitution

C = (Y-T) + u Keynesian consumption

I = Q R + v Investment driven by cost of capital
R = BP W + x
Q = W KP R + z
Y = C+I
W = QKP + BP + M Assets: risky K; safe B; money M
M = QKM + BM Central bank balance sheet
K = K P + KM
B = B P + BM
T = R-1BP-1 QKM-1

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 Model with Imperfect Asset Substitution
Endogenous: C, I, Y, R, Q, W, KP, BP, T, M
Exogenous: u, v, x, z (shocks); K, B (asset stocks); KM, BM (policy)
Parameters: , , , , , , , are nonnegative.
Normalize around steady state at zero.

Y = [(+)BM + KM
(+)x + z + u + v] / (1)

It is plausible that > +, so that KM effect > BM effect.

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 Case Study 1: Thailands Bank Recap

Thailand and Indonesia had large asset bubbles

with unproductive investment financed by
foreign borrowing.

Koreas problems were less extensive.

Chaebol profits were declining below cost of funds.
But smaller net foreign inflows and outright waste.

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 Case Study 1: Thailands Bank Recap

Thailand focused on bank recapitalization with

public funds, run by the central bank.
Monetary policy was kept moderately tight.
Korea focused on depositor protection and
liquidity provision.
Monetary policy also kept moderately tight.
Indonesia slower to respond and less coherent.
Too much monetary finance.

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Source: IMF International Financial Statistics.

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Source: IMF International Financial Statistics.
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Source: IMF International Financial Statistics.

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 Case Study 1: Thailands Bank Recap

Both Thailand and Indonesia had large

fundamental shocks.
Thailands more focused program with sound
monetary policy led to better results.
Despite larger fundamental shock, Thailand did
about as well as Korea.
Thailands publicly funded bank recap took more risk
out of private hands than Koreas liquidity support and
paying off depositors.

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Source: Haver Analytics.
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Source: Haver Analytics.
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 Case Study 2:
Hong Kongs Stock Market Rescue

Hong Kong did not have excessive investment

or foreign-currency debts.
Hong Kongs hard peg to the US dollar made it
uncompetitive when its external demand was
already falling.
Hedge funds and other speculators attacked the
currency, forcing up interest rates, which further
weakened Hong Kongs economy.
Double play in currency and stock market.

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Source: Haver Analytics.
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Sources: Haver Analytics, Hong Kong Monetary Authority, Monetary Authority of Singapore.
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 Case Study 2:
Hong Kongs Stock Market Rescue

HKMA bought 10% of Hang Seng index in

August 1998.
Funded by bonds not money creation.
Reduction in govt deposits at local banks.
Raised stock prices ~25% on impact.
Stock prices later doubled with global recovery.
Prevented ongoing recession from deepening.

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Source: Hong Kong Monetary Authority.

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 Conclusion

Central banks (and governments) have more

tools than previously thought.
Conventional monetary policy lowers the short-
term interest rate in a recession.
If rate hits lower bound or is constrained by
another objective (exchange rate)
Reduce risk premiums and term premiums by
buying risky assets and long-term bonds.
Can be overdone. Not a panacea.

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