1 - The Global Financial Crisis: Impact and Response in East Asia

Summary

The “Great Recession” and East Asian Economies

The global economy has barely recovered from the recent shock of the “Great Recession”, which originated in the United States in 2008, first as the twin crisis of the subprime mortgage meltdown and the bursting of its housing bubble, and then quickly engulfed Wall Street to develop into the worst global economic crisis in decades.

The main causes of this financial crisis are now sufficiently well known. They include: (1) A long period of loose monetary policy, along with low interest rates in developed economies, generating too much easy liquidity to fuel excessive financial speculation activities; (2) Excessive “innovation” in the financial sector, leading to the proliferation of too many unsound financial products and too many complex financial instruments, for example, structured products such as CDOs (collective credit obligations) and derivatives such as CDSs (credit default swaps); (3) Deficient and inadequate regulations and supervision on banks and financial institutions, particularly the investment banks, e.g. many of their off-balance sheet activities; and (4) Failure of credit rating agencies in rating the many complex debt instruments correctly.

Meanwhile, as the global financial sector has basically recovered from the crisis, finance ministers, central bankers, and financial bureaucrats in the developed countries are busy debating and deliberating on a plethora of new policy measures to regulate the operations and practices of the financial sector in order to prevent the recurrence of similar crises in future. Many economists are also taking a critical look at the relevance and applicability of time-honoured economic theories such as rational expectation and the efficient market hypothesis that had been widely received and practised by financial economists and financial sector players.

When looking back, many economists have been greatly surprised not just by the rapid spread of the financial tsunami from one market to another, but by how rapidly the financial sector crisis had brought down the “real sectors” (production, exports, and employment) of the economy, that is, how the problems in “Wall Street” have been so quickly transmitted to “Main Street”.