Ebook The US Sub-prime Crises and Extreme Exchange Market Pressures in Asia
Despite the uncertainties and the fear of another round of the financial crisis that occurred in 1997 in Asia, the emerging markets of Asia have emerged relatively well from the recent sub-prime global financial crisis. By the third and fourth quarter of 2009, the Asian economies in general, reported positive trade balances and net current account balances. Signs that rapid economic recovery is on course can also be traced from their GDP growth rates. Moreover, the return of a continual inflow of portfolio capital starting in late 2009 confirmed the renewal of market confidence in the near term outlook of these Asian economies. Unprecedented fiscal and monetary policy stimulus packages in 2008 and early 2009 have contributed significantly to their rapid recoveries (Tables 1 and 2). The ability of the policy makers to maintain financial stability and prevent a severe credit crunch from taking place, has also given a major boost to their overall economic performances (Siregar and Lim (2010)).
Among many aspects of a financial crisis, the sudden rise in exchange rate volatility has always been a major source of concern for policy makers. For instance, during the 1997 Asian financial crisis, the large swings that involved severe depreciations of the local currencies exacerbated the fundamental weaknesses of the affected economies. The weak currencies forced many financial institutions and their clients into debilitating insolvencies (Lane (1999)). In tandem with the credit crunch, particularly sharp falls in trade credits, volatile local currencies were responsible for the collapse of the trade and other sectors of the economies in several major East and Southeast Asian economies such as Korea, Indonesia and Thailand during the 1997 crisis.
The sub-prime crisis is no exception. The fear of another round of meltdowns of local currencies, which would then be followed by episodes of volatile swings in the rates, was particularly prevalent following the collapse of Lehman Brothers in last quarter of 2008. The past and recent economic and financial crises have underscored the role of exchange rate volatility as a key transmission channel of a financial sector meltdown to a wide spread slowdown in the real sector. The exchange rate volatility has also undermined the ability of monetary authorities and central banks to manage price stability. Evidences based on their monetary policy reaction functions demonstrate that inflation-targeting economies around the globe, including those in Asia, has in fact, paid close attention to the volatilities of the local currencies before making necessary adjustments in their key policy rates (Aizenman, et.al. (2008) and Siregar and Goo (2010)).
To manage the exchange rate volatility, central banks have often resorted to multiple policy instruments. Buying and selling foreign exchange reserves and policy rate adjustments are arguably two of the most frequently adopted instruments. Any excess demand for foreign exchange, responsible for the volatility, can be fulfilled through non-mutually exclusive conduits. If the market or currency pressure is successful, there will be a sharp depreciation of the domestic currency. However, at other times, the market pressure can be repelled or warded off through raising interest rates and/or running down on the foreign exchange reserves. Combining the information on exchange rate fluctuation, interest rate adjustment and reserve movement should convey a more informative and reasonable measure of the extent of pressures on a currency referred to as the index of exchange market pressure. This concept of exchange market pressure and its application have been elaborated in numerous studies, especially around the pre and post-1997 Asian financial crisis (Eichengreen, Rose, and Wyplosz (ERW) (1995, 1996), Pozo and Dorantes (2003), and ADB (2005)).
The primary objective of this study is to examine evidences of occurrences of extreme market pressure against the local currencies of a number of major Asian economies of the SEACEN group against the US dollar during the period of 2000-2009. In particular, we are interested to investigate the severity of these pressures during the recent sub-prime crisis of 2007-2009. Have the currencies of these economies been indiscriminately under selling pressure during the period of the recent global financial crisis? Has the height of the selling pressures been associated with a particular event during the recent sub-prime crisis, such as the collapse of Lehman Brothers? Lastly, are there lessons to be learned in light of our findings with regard to the supposed linkages between macroeconomic stability and financial stability, otherwise known as macro-financial links?
The rest of the paper is organised as follows. Section 2 briefly reviews the basic construction of the EMP index as proposed by Eichengreen et al (1995, 1996). The extreme value theory and the Huisman et al (2001) estimator will be discussed in Section 3. Section 4 presents the constructed EMP index for the individual countries and some basic statistical properties of the EMP indices. Section 5 discusses the empirical results of the implementation of the extreme value approach. Section 6 reports the episodes of extreme pressures against the local currencies of the Asian economies under study. Section 7 examines the close association of the Lehman-Brothers’ collapse to the identified episodes of extreme market pressures during the recent sub-prime crisis. Section 8 concludes the paper.
Contents
Abstract
1. Introduction
2. Eichengreen, Rose and Wyplosz (1995, 1996)
3. Extreme Value Theory
4. Basic Trends and Statistical Properties of the EMP Indices
5. Extreme Values
6. Episodes and Incidence of Extreme Market Pressures
7. The Extreme Pressures of the Lehman-Brothers and Macro-Financial Links
8. Brief Concluding Remarks
References
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