Modelling the Crisis in Asia

Abstract

This paper gives an overview of studies that have attempted to model the crisis in Asia. Although no model-based research predicted the crisis, modelling results have given useful insights into the cause of the crisis as well as the sectoral and macroeconomic adjustment to be expected following the crisis. Some alternative policy responses have also been simulated; these throw light on how to respond to the Asian crisis within and outside Asia. Introduction The crisis in Asia has presented challenges across a broad spectrum. Apart from the severe problems facing individuals and governments in the affected countries, as Garnaut (1998) has noted, the crisis has also presented a challenge to economic thought. This challenge is clearest for the theoretical and empirical knowledge embodied in multi-country economic models. One may ask whether these models have been of any use in explaining the crisis and subsequent adjustments. Have the economic theories and mathematical representations of these theories been shown to be totally inadequate in the face of such a dramatic event as the Asian crisis? The purpose of this article is to provide answers to this question by surveying the studies of the Asian crisis that have been undertaken using multi-country economic models. Although only simplified representations of complex economic systems, the models have provided a number of insights into the crisis and its impact on the rest of the world economy. Existing model-based studies can be divided into three categories: modelling studies that predicted the crisis; studies that have used multi-country models to explain the crisis ex-post; and studies that have examined the adjustment process in response to the crisis in individual crisis countries as well as globally. There would seem to be no modelling studies that predicted the crisis in Asia ex ante. A study by McKibbin and Martin (1998), which is a background paper for the recently published World Bank study on East Asia: The Road to Recovery, attempted to evaluate alternative explanations of the causes of the crisis by using a multi-country economic model to identify shocks. Revisions to expectations about growth prospects, shifts in risk perceptions and expectations about policy responses are shown in that paper to go a long way to giving consistent explanations of the extent of the exchange rate changes and asset price collapses experienced in the crisis countries. All the other studies fall into the final category of exploring the nature of the adjustment both within crisis economies and outside, following after the initial crisis. Very few of these models deal explicitly with international capital flows and even fewer deal with dynamic adjustments between equilibria. Yet these aspects of the Asian crisis are crucial for understanding the adjustment process. Some recent newly-developed dynamic intertemporal general equilibrium models have this characteristic and therefore dominate the studies to date. These intertemporal models, based on what I have called the G-Cubed model, were used to examine: the impact of changes in risk perceptions and productivity collapses on Asian economies and the transmission of the shock to the rest of the world, through both international trade and international capital movements (McKibbin 1998a; McKibbin 1998b); and the impact on local and world agricultural markets (Coyle et al. 1998; Stoeckel et al. 1998). Two studies using computable general equilibrium models, by Noland et al. (1998) and Kawasaki (1998), looked at the impact of the crisis on the composition of international trade flows and economic structures within and outside Asia. Finally, a study at the OECD (1997), using the INTERLINK multi-country econometric model explored the links between Asia and the OECD economies, primarily with a focus on the impact of the crisis on OECD economies outside Asia. Insights on Causes of the Crisis There are now a number of excellent overviews of the crisis and a vigorous debate on the causes (see Corsetti et al. …