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Contents Introduction

This paper examines several aspects of the financial crisis in East Asian economies. First, the paper examines the economic events that preceded the crisis. The major focus is on countries that have been directly involved in the crisis, Japan since the early 1990s and then Thailand, Korea, and Indonesia since 1997. Special attention is also played to the increasingly important role of China and to interactions among these and other economies in the region. Second, the paper examines some of the important economic principles that must be considered to understand the crisis and its evolution. The principles emphasized relate to (1) fluctuations in asset prices and economic cycles, (2) the formulation and implementation of prudent financial sector regulations, and (3) the coordination of economic reforms in the transition from a highly protected, highly regulated economy (such as Thailand, Korea, and Indonesia in the 1980s) to a less protected and less regulated economy. Third, the paper examines prospects for the future resolution of the crisis. In the short-run the prospects for the most countries in the region, especially those directly affect by the financial crisis, are not very good. Furthermore, medium-run prospects for Japan, Thailand, Korea, and Indonesia, are also highly uncertain. An optimistic scenario would suggest that large fiscal stimulus in Japan and prudent policy reform focused on the financial sector in all of these economies could result in a relatively rapid return to modest growth rates. On the other hand, if Japan’s fiscal stimulus is ineffective or if financial sector reforms in Japan, Thailand, Korea, and/or Indonesia are delayed or ineffective, the scenarios become far more pessimistic. In addition, there are very large differences between the optimistic and pessimistic scenarios. Finally, the rest of Asia will also be affected and China in particular must take care to avoid the same policy mistakes that were made in Thailand, Korea, and Indonesia, as it has several of the same characteristics that these countries had before the crisis.