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Asian Crisis: An Interview with Nouriel Roubini

Nouriel Roubini has generously agreed to answer a few questions about
the causes and consequences of the on-going Asian currency and economic
crisis. He also shares some thoughts on the implications for policy and
for the analysis of currency markets.



Roubini is an Associate Professor of Economics and International Business
at the Stern School of Business, New York University.  He is the author
most recently of Political Cycles and
the Macroeconomy
as well as numerous academic papers. Some of his recent
work has focused on the causes and consequences of the Asian currency crisis.
He received his Ph.D. from Harvard in 1988 and was previously an Assistant
and Associate Professor in the Economics Department at Yale University.
Roubini is also a research fellow at the National Bureau of Economic Research
and the Center for European Policy Research; and is a visiting Economist
at the IMF and consultant to the World Bank.


Impact of the Crisis


Q:  Is the currency crisis likely to impact the long-run performance
of the Asian economies? Is this the end of the Asian miracle?


The Asian miracle might have been over even without the crisis. These
countries could not possibly grow forever at 8-10% per year rates, as diminishing
returns at some point kick in. Also, the evidence in Young, popularized
by Krugman, suggests that the role of total factor productivity growth
was limited in Asian growth; a lot of growth was due to inputs growth (labor
and capital especially). Rate of investment of 40% of GDP per year are
not sustainable forever and savings rate are bound to fall over time.

So, even if these countries whether the crisis, the growth rate might
not return to the high levels pre-crisis; 4-5% per year may be more reasonable.

Mexico was back to growth in 1996 after the 1995 recession following
the 1994 collapse of the Peso. A recession might be deeper and persist
for much longer in Asia for several reasons:

  1. The Tequila effect did not spread so dramatically from Mexico to the rest
    of Latin America while in Asia as Argentina’s and Brazil’s pegs resisted;
    however in Asia one after the other most currencies collapsed with the
    ensuing recession that is going to follow being exacerbated by the recession
    in the neighboring countries.

  2. The US was in a strong cyclical upswing in 1994-95, something that helped
    Mexico and the rest of Latin America while growth in Japan, the main regional
    economy, has been stagnating close to zero since 1991.

  3. The US had cleaned up its banking problem (the S&L crisis) by 1994
    while the Japanese banking problems are still unsolved and Japan is heavily
    exposed in Asia.

  4. The game of competitive devaluation that has been observed in Asia was
    largely avoided in Latin American following the Peso collapse; most currencies
    in L.A. resisted and this presented a recessionary competitive devaluation
    game (as the one currently observed in Asia that is similar to that in
    the 1930s depression).

  5. There was a lot of over investment and capacity glut in Asia; for example,
    Korea overbuilt in low-tech semiconductor (DRAM) plants whose profitability
    is going to be very low in the medium term; same thing for shipping, steel
    and other traded goods. Also, the glut of non-traded goods, especially
    real estate will lead to low returns in these sector for a long time.

So it is not clear whether Asia will look ex-post more like Mexico that
had a one-year severe recession and then resumed growth or more like Japan
whose economic model has stalled and whose growth has stalled  since


Q:  How much of an impact will the Asian currency crisis have on the
economies of the US and other western economies? How long will it take
before this impact will be felt?


Growth in US and Europe will be reduced by about a 1/2% point in 1998
unless Japan, who is already stagnating, plunges in a deeper recession.



Q:  In your paper What
Caused the Asian Currency and Financial Crisis
, you point to the moral
hazard problem as being one of the main contributors to the crisis – is
this feature stronger in the Asian crisis versus other past crises? If
so why? 


Most episodes of Balance of Payment crisis in emerging economies are
episodes of Twin Crises where a balance of payments crisis is associated
with a Banking crisis (see the evidence in Kaminsky
and Reinhard (1996)
. And most of these banking crises are caused over
borrowing and over lending due to poor regulation poor supervision following
financial liberalization and the presence of a moral hazard problem deriving
form implicit and/or explicit government promises of a bail-out in case
things go wrong. So moral hazard is important but is only a part of the

The crisis is not just a debt crisis, it is also a currency crisis.
By 1997 most of the regional currencies were overvlalued and fixed rate
regimes and excessive short-term capital inflows led to significant real
appreciation. The current account deficits were very large and driven both
by the overvaluation and the (moral hazard driven) overinvestment. So,
we are talking of a currency AND debt crisis where moral hazard was one
factor, among several other fundamental problems and policy mistakes.


Q:  Your paper describes the “investment boom” as “excessive and often
in the wrong sectors of the economy”. You also conclude that a significant
portion of the borrowing was used for speculation rather than real productive
investment in capital goods. Should lenders be more careful about specifying
and monitoring the uses of their loans?


Of course, they should be, but moral hazard at various level led to
the lack of monitoring.

International creditors did not monitor and overlent to domestic banks
and financial intermediaries under the implicit or explicit promise that
they would be bail-out, either by the governments and/or via IMF supported
packages. Domestic banks and financial intermediaries did not monitor for
many reasons, mostly related to the implicit promise of a government bail-out
in case things went wrong:

  1. Their risk capital was usually small and owners of banks risked relatively
    little (by lending to excessively risky projects) if the banks went bankrupt;

  2. Several banks were public or controlled indirectly by the government that
    was directing credit to politically favored firms, sectors and investment

  3. Depositors of the banks were offered implicit or explicit deposit insurance
    and therefore did not monitor the lending decisions of banks;

  4. The banks themselves were given implicit guarantees of a government bail-out
    if their financial conditions went sour because of excessive foreign borrowing.

The outcome of all this was twofold: first, banks borrowed too much from
abroad and lent too much for investment projects that were too risky; second,
because of these implicit public guarantees of bail-out, the interest rate
at which domestic banks could borrow abroad and lend at home was low (relative
to the riskiness of the projects being financed) so that domestic firms
invested too much in projects that were marginal if not outright not profitable.
Once these investment projects turned out not to be profitable, the firms
(and the banks that lent them large sum) found themselves with a huge amount
of foreign debt (mostly in foreign currencies) that could not be repaid.
The exchange rate crisis that ensued made things only worse as the currency
depreciation dramatically increased real burden in domestic currencies
of the debt that was denominated in foreign currencies.

In summary,  fixed exchange rates regimes, capital inflows and
moral hazard jointly led to real appreciation, an investment boom in wrong
sectors, an asset price bubble and large current account deficits that
led to accumulation of a large stock of short-term foreign liabilities.
Such deficits were financed mostly through banking system intermediation
(given the lack of developed securities markets in the region): banks borrowed
abroad in foreign currency and their borrowings were mostly short-term.
These large currency positions were mostly unhedged as firms and banks
expected the fixed exchange rates to be maintained and/or to be bailed-out
if things went wrong.

Once the firms’ investment projects turned out not to be very profitable,
the firms and the banks found themselves with a huge amount of currency-denominated
foreign debt that could not be repaid. The exchange rate crisis that followed
made things only worse as the currency depreciation increased the real
burden of the foreign-currency denominated debt. The behavior of weak and
not very credible governments that were not committed to structural reforms
exacerbated the policy uncertainty and the financial panic that followed.



Q:  You argue that, in conjunction with other factors, large current
account imbalances coupled with fixed exchange rates lead to a overvaluation
of several Asian currencies. Should we have seen speculative attacks and
a crisis coming? Could it have been prevented?


If you looked carefully at the fundamentals you should have seen that
a currency crisis had to occur. For example Thailand and Malaysia had all
the symptoms of Mexico by early 1997: huge current account deficits (close
to 10% of GDP for a decade), real appreciation, asset bubble, overinvestment
in wrong projects, weak and fragile banking systems.


As in the case of Mexico, by the time we got close to the crisis it
was very hard to prevent it. Policies should have been different several
years earlier: i.e. avoid excessive capital inflows via controls on hot
money inflows; a more flexible exchange regime aimed at maintaining a stable
real exchange rate; greater supervision and regulation of the financial
system; policies to avoid short term foreign debt borrowing by banks and
firms; development of securities markets (debt and equity) to prevent that
most of the capital inflows be intermediated through the short-term channels
of the banking system.


Q:  There has been some debate over the role of the IMF in providing
stabilization funds for currency crisis. Bailing out failing organizations
obviously contributes to the moral hazard problem mentioned above. Is there
some balance we can strike between legitimate stabilization programs and
generating the moral hazard problems? (i.e. can the time consistency problem
be addressed in a useful way?)


There is some tradeoff: repeated bailouts signal to creditors that
they can take risky gambles and pay no cost, a huge incentive to repeat
the same mistakes over and over again. On the other side, the IMF should
have a role of lender of last resort. Unfortunately, the bailouts in Asia
suggest that no country seems to be too small (not too big) to be allowed
to default. That’s a bad signal for the future; the IMF might have lost
some credibility in the process.

Probably, the only way to avoid future mistakes is to make sure that
international creditors pay some costs for their risky decisions: they
should not be fully bailed out. For example, Korea, Indoenesia and the
other countries should not give new public guarantees for the debt of private
companies; also, for the debt of the banks, any rescheduling agreement
should imply some losses for the international creditors. Unless the US,
Japanese and European banks get burned with fire, they will play with fire



Q:  The volume of media coverage and analysis (probably primed by the
Mexican crisis) has been extraordinary. Are there any common misperceptions
about the causes and consequences of the crisis?


One misconception about the causes is that it was all due to irrational
speculation and irrational contagion. Fundamentals were quite weak in the
region and these fundamentals triggered the crisis. Of course, there has
been a certain amount of overshooting once financial panic ensued. The
rupiah had to devalue, but a 15,000 rate to the US dollar is pure folly
and not justified, even when you weigh in the important role of policy
and political uncertainty. So there has been an overreaction of asset markets
but based on bad fundamentals to begin with: a strong wind can collapse
a big tree only if its roots are rotten.


Q:  You also suggest that traditional models of currency crisis are
inadequate to the extent that they do not emphasize the moral hazard or
the multi-country “contagion” effects. What do you think will be the main
policy implications of a “third generation” of models.


‘Third generation’ models are still work in progress as many of us
are working on these ideas. The systemic multi-country nature of the problems
and the twin-crisis phenomenon suggest several policy implications:

    1. There should be more credible monetary policy cooperation and coordination.
      In the case of the ERM in 1992-93 there was a breakdown of cooperation
      (as the recent monograph by Buiter,
      Corsetti and Pesenti (1998)
      suggests). In Asia cooperation was harder
      as these countries has unilateral pegs to the US dollar and were not tied
      in a formal cooperative exchange rate regime like the ERM.

    2. Excessively volatile capital flows are a serious problems and can exacerbate
      a crisis. Controls on excessive short-term inflows, such as those imposed
      in Chile look more and more appealing; short-term borrowing by banks and
      governments should be avoided. More extreme solutions such as a Tobin tax
      on capital flows should be considered more seriously.

    3. Moral hazard problems should be avoided via prudential regulation and supervision
      and avoidance of government bail-out promises. Opening domestic financial
      system to foreign banks, as done in Argentina and Mexico, can only help.

    4. Fixed rate regimes are fragile, even more so when many regionally integrated
      economies have a formal or informal system of pegged rate. As the 1990s
      crises (ERM in 1992-93, Mexico and Tequila in 1994-95 and Asia in 1997-98)
      suggest some degree of exchange rate flexibility is beneficial. If countries
      really like fixed rates, then they should go to the extreme: give up a
      domestic currency and form a monetary union. Even currency boards, a strong
      form of fixed rates, are fragile: if the currency board in Hong Kong collapses,
      quite likely now that all the regional currencies have devalued, Argentina
      could go under too. Also, currency boards are likely to be phased out in
      East Europe, especially Lithuania and Estonia as they have led to severe

    5. Fixed rate regimes may be useful in early stages of a stabilization program
      when, starting from high inflation, they focus expectations on a low inflation
      equilibrium. After that, it is better to switch to a more flexible regime.


Q:  Do you see currency crisis as a permanent fixture on the economic
landscape or will we eventually learn how to effectively stabilize international
financial markets?


A cocktail of greater international capital mobility, financial liberalization,
short-term-oriented trigger-happy and sleep-deprived fund managers and
currency traders, and fixed exchange rates can be deadly.  Some broad
international effort to stabilize markets, enforce prudential regulation
and supervision of otherwise unsupervised offshore financial institutions
and poorly supervised onshore ones should be considered.

See Also:

Filed under: International

The Asian Currency Crisis

It seems like every day a new story breaks on the financial and economic
crises in Asia. Aside from being a good source for news on the Asian currency
crisis, the Internet can also be a good place for finding quality analysis
of the problems.

Below I present some useful sources of information and anaylsis on the
causes and consequences of the crisis as well as analysis of the International
Monetary Fund’s policy response.


The consensus that seems to be emerging is that short term loans from
foreign banks coupled with poor investment strategies created a fundamental
instability in the region’s currencies. The poor investments are seen to
be largely a consequence of financial intermediaries which had an (implicit)
government guarantee on their liabilities and the resulting moral
hazard problem

non technical

Blame Short-Term Loans for Asian Crisis
in the New York Times.
Paul Krugman
on the causes of the crisis
in Slate from August. Jeffrey
Sachs on the causes of the crisis
from early on in the melee, July
30, from the Financial Times.

research oriented

Nouriel Roubini, Giancarlo Corsetti and Paolo Pesenti have a longer
research paper
on the causes of the Asian Crisis.

Krugman also has a more recent and detailed research
on the topic. For background into the theory and past crisis I
would also recommend his background
from a NBER conference in October.


Will the crisis spread to other economies? The so called contagion
effects are getting more attention this time around.

the financial crisis could affect you
is a series of BBC reports on
how the crisis will effect the world’s economies. Greenspan’s
Testimony to the House on 11/13/97
also has some thoughts on the possible
effect on the US economy. For more the contagion effects of the past latin
american crisis see the listings
in Roubini’s page.

IMF Response

There has been quite a bit of debate over the role of the International
Monetary Fund (IMF) and its handling of the crisis. A recent discussion,
NewsHour: The IMF and Asia
, asks Lawrence Kudlow, Robert Hormats, Jeffrey
Sachs, and Mary Bush about their views. The background
is also a good place to start in assessing the IMF’s actions.

Another good place to look for information is to directly to the IMF
for their analysis of the situation in the IMF
World Economic Outlook Dec. 1997–Crisis in Asia: Regional and Global Implications

other critiques

Jeffrey Sachs on the IMF and the Asian crisis from the New
York Times
and the Financial
or Cure
is The Economist‘s take on the IMF plans.


Bail Outs: Truth and Fiction
contains a defense against the charge
that the bailout targeted preferred groups.

Crisis hotline – where to stay in touch

The crisis is not over yet, there are sure to be new developments just
around the corner. Here are some places to keep in touch.

Asia Crisis Homepage
by Professor Roubini at the Stern School of Management
contains many more links on the Asian crisis as well as issues related
to currency crashes in general. This is a great source for deep analysis
into the issues.

York Times
Homepage on the Financial Crisis in Asia
is a good starting
point for reviewing both past news events and keeping up with new developments.
The Washington Post also maintains a similar site with news and
analysis at
Asian Financial News

NewsHour Online:
presents news and commentary on the crisis as well as links to
other NewsHour coverage of the topic. See also Online
NewsHour Forum: Asian Turmoil

For a more detailed view of the crisis see OTN
explores Asia’s economic crisis: country by country guide

See Also:


Moral Hazard Problem 

If you spend much time around economists you will start to hear the
phrase “moral hazard” or “moral hazard problem” with great frequency. Below
is an example of the problem for investment decisions 

Say that an investor has the choice between two projects. The first
project is “safe” in that it will with certainty earn a small amount of
profits. The second project is risky and will either get the investor large
returns or larger losses. 

If the size of the losses are large enough for the risky project, the
investor will choose the safe project to maximize her expected profits. 

The moral hazard problem arises when some outside authority (such as
the government, parent company, or some other organization) provides a
guarantee against losses, but is unable to specify or monitor the type
of investments. The investor – now facing a choice that includes a risky
project with a limit on the losses – may choose to invest in the riskier

In general the term moral hazard is used when some incentives are introduced
that distort the optimal behavior of some economic agent in an environment
where the actions of the agent are unknown to the person or organization
providing the incentives. Because the actions are know to only the agent,
she can alter her behavior in such a way as to best take advantage of the
incentives offered. 



Filed under: International

How to Simplify the Tax Code

Hey! Guess what I got in the mail this past week – my 1040
! Yea!

1998 is an election year, and as always taxes will be on the agenda
of people running for office as well as on the minds of the electorate.
One of the most common components contained in most fundamental tax reform
proposals is a promise to “simplify” the tax system. Filling out your tax
forms can be a pain in the rear and it certainly would be nice to have
only a postcard sized tax form to fill out. In Denmark, most people get
sent a statement of their tax account which they only have to sign and
return – nothing to fill out or calculate.

So, what is it that makes income taxes complicated? Contrary to many
of the recent claims by tax reformers, multiple rates do not complicate
things in the current system. The “flat tax” – by which I mean creating
only one tax bracket – does not by itself simplify anything:
only the table which you use to look up your tax would change.

The real effort in filing out your tax form comes from two primary sources:
1) dealing with tax rates that differ by source of income, and 2) dealing
with various deductions and exemptions.  To substantially simplify
tax returns, we must remove the individuality from tax determination. I
have one suggestion to add to the list below.


In short, the reason that the tax forms you fill out are complicated
is that the IRS needs a good deal of information in order to calculate
exactly how much tax you owe.

For example, on the 1997-1040 form you have to list income from wages,
interest, dividends, capital gains, alimony, business income, IRA distributions,
pensions, rental real estate, farm income, unemployment compensation, social
security benefits, and, of course, “other”.

On the deductions and credit side you have to list deductions related
to IRAs, Medical savings accounts, moving expenses, self employment, health
insurance, Keogh plans, alimony paid, early withdrawal of savings, and
of course you might have to itemize your deductions for charitable giving
or mortgage interest.

To substantially simplify anything, we need to get rid of the preferential
treatment of different type of income and the variety of deductions – in
short, we need to remove individuality from tax forms.

Proposal for Simplifying the Charity Component

Removing the need to itemize charitable deductions would go a long way
in simplifying the tax code. One way to do this is to simply remove the
deductibility of charitable giving. “Wait, Wait!” I hear you yelling “Giving
is something that should be encouraged!”

Ah-ha! There is a way, however, to keep the current preferential treatment
of charitable giving without mucking up tax forms. Rather than giving you
a tax deduction, the federal government could instead match the funds as
they are contributed to the non-profit organization. The matching
would give the same amount of preference as the tax deduction.
See the table below for an example.


Current system: 



Income: $110
Giving: $10 

Taxable income: $110 – $10 = $100
tax rate: 30%, so tax:  $30
income after giving & tax $100 – $30 = $70


Bottom line: $10 to charity, $70 left to spend.
My Proposed system: 



Income: $110
Giving $7 (+ 3$ matching) = 10$
Taxable Income $110
tax rate: 30%, so tax  $33
income after giving & tax $110 – 7$ – $33 = $70


Bottom line: $10 to charity, $70 left to spend.  


And no Deductions to itemize!

This system would also remove one of the more perverse aspects of the current
system — those at the higher tax brackets are currently rewarded more
for giving. By setting a single matching rate this preference would be


You will undoubtedly hear quite a bit in this next election season about
simplifying the tax system. It will be important to keep in mind what makes
the system complex and to make sure that the proposed simplifications match
the present complexities.

The calls that will be made for a flat tax must be evaluated in this
light. If the proponents only talk about creating a single rate – and do
not address the various deductions and income source differences – they
are not talking about simplifying your tax return. The reason for the omission
is obvious – people like their deductions – and talking about simplification
in the abstract is politically much easier than talking about removing
beloved deductions.

And, as a service to all of my kind and generous readers, my proposal
for charitable deductions would ease the pain associated with itemized

See Also:


The “Flat Tax” may or may
not be more simple. 

Current system 

If a single rate “flat tax” is superimposed on the current system which
includes various types of deductions (e.g. IRA’s, charity) and preferential
treatment of certain kinds of income (like capital gains) there will be
no real simplification of the tax code – you would still have to fill out
roughly the same form as before. 

The only difference would be in the table in which you look up the amount
of tax you owe. 

Simplified system  

There is a case when a flat tax would simplify tax returns. 

If we were to remove all deductions, exemptions, etc., then a single
rate tax would allow the IRS to collect the tax directly from businesses,
and no real tax filing would be necessary. 

The reason that we need to file taxes is because taxes are very much
based on individual or family characteristics. The amount of taxes you
owe in the current system depends both upon your earnings as well as other
characteristics of your household (such as the earnings of your spouse,
charitable giving, number of kids, etc.). 

If we change our system so that no individual information is needed
to calculate your tax rate, then taxes can be withheld at the employer
level without having to fill out a return in April. The “flat tax” would
remove the need for the IRS to know your total income before calculating
the correct tax to collect.



Calculating the Matching
Rate for giving.

Current system 

yd is total income (y) after tax (rate t) and contributions (c). 

yd = y – (y-c)t – c 

yd = y(1-t) – c(1-t) 

Simplified system  

yd’ = y(1-t) – c’ 

where the ‘ denotes the new system. 

To equate final incomes under the two systems we get 

yd’ = yd 

y(1-t) – c(1-t) = y(1-t) – c’ 



In order to contribute the same amount to the charity under both systems
we must have a matching rate (m) that sets 

c = m*c’ 


c = m*c(1-t) 


m = 1 / (1-t).


Filed under: Economics, Policy

1998: More of the Same?

You know it’s been a good year for the U.S. economy when public debate
turns to trade policy. People don’t have inflation
or high unemployment to worry about, and the stock market is doing well.
Productivity is picking up a bit. Even the federal deficit seems to have
disappeared before our eyes! There is still the nagging problem of stagnant
wages at the lower end of the income distribution, but it appears that
some small progress is being made on that front.

Since it is the end of 1997, I thought I’d spend a bit of time assessing
the performance of the economy over the past year and looking ahead to

Just The Facts



1996 1997
Real GDP Growth* 2.7% 3.9%
Productivity Growth*  1.4% 2.5%
Unemployment Rate* 5.3% 4.6%
Growth in Avg Real Wkly Earnings* 0.6% 3.1%
CPI Inflation* 3.2% 1.8%
Federal Deficit* $250 Billion $188 Billion 
Savings Rate* 4.1% 4.2%
Interest rates (federal funds)* 5.30% 5.46%
Interest rates (morgage)* 7.8% 7.6%
Consumer Confidence*: 28 Year high at 134.5

Note: Most data is current through November. Comparisons
are made to equivalent period in previous year.

New Economy vs. Law of Averages

So, will the economy continue to do as well in 1998?  There seem
to be two camps on the subject.

The first consist of those who extoll the powers of the “New Economy”
or the “New Economic Paradigm”. These optimists believe that the battle
against inflation has been won and that fundamental changes in the economy
have, in effect, raised the speed limit. I’m being intentionally vague
about the “fundamental changes” since the term “New Economy” has no clear
definition and means many different things to many different people – although
a perceived (if not measured) increase in the rate of technological progress
seems to play a role in most of the stories.

On the other side are the pessimists who see the economy nearing the
upper end of its potential, and are waiting for something to break. In
particular, they are waiting for the tight labor market to force wage increases.
This will in turn lead to price increases, which will then force the Fed
to clamp down on the economy to stop emerging inflation.

Also, part of this second crowd are the true believers in the “Law of
Averages”. Everyone knows this law: if you flip a fair coin 5 times and
each time it comes up heads, the next time it’s almost certainly going
to come up tails. Much economic reporting seems to rely on this “Law” –
how many times has the announcement of good economic news been followed
with “but how long can this go on…” As such this camp has seen a long
streak of good years and believe that the next will almost certainly see
a downturn.

My predictions

What will 1998 bring for the economy? I must say that I’m skeptical
about my own ability to gaze into the crystal ball to predict the future.
The consensus forecast (I’m guessing here) is that the economy will slow
somewhat in 1998, but will remain fundamentally healthy.

For my own view, I’ve been somewhat surprised by the lack of an inflationary
response to the strong economy – this seems to point to the possibility
that the current strength may be sustainable for the near future. Of course,
I wouldn’t be a good economist if I didn’t point out the other side of
things – I’d say that there is a decent (say 35%) chance that inflation
will blip up early in the year bringing Fed action resulting in a slowdown
by the third or fourth quarter. My other 65% says that 1998 will look a
lot like 1997.

If you want my specific predictions – just replace “1997” in the table
above with “1998”.

See Also:

Filed under: Economy