Working Paper: CEPR ID: DP1866
Authors: Hali J. Edison; Pongsak Luangaram; Marcus Miller
Abstract: Credit market imperfections have been blamed for the depth and persistence of the Great Depression in the US. Could similar mechanisms have played a role in ending the East Asian miracle? After a brief account of the nature of the recent crises, we use Kiyotaki and Moore?s (1997) model of highly levered credit-constrained firms to explore this question. As applied to land-holding property companies, it predicts greatly amplified responses to financial shocks ? like the ending of the land price bubble or the fall of the exchange rate. The initial fall in asset values is followed by the ?knock-on? effects of the scramble for liquidity as companies sell land to satisfy their collateral requirements ? causing land prices to fall further. This could lead to financial collapse where ? like falling dominoes ? prudent firms are brought down by imprudent firms.Key to avoiding collapse is the nature of financial stabilization policy; in a crisis, temporary financing can prevent illiquidity becoming insolvency and launching ?lifeboats? can do the same. But the vulnerability of financial systems, like those in East Asia, to short-term foreign currency exposure suggests that preventive measures are also required.
Keywords: credit market imperfections; asset price bubbles; financial crisis; illiquidity; insolvency
JEL Codes: E32; G21; G32; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial shocks (F65) | Asset price decline (G19) |
| Asset price decline (G19) | Credit-constrained firms selling assets (G32) |
| Credit-constrained firms selling assets (G32) | Financial distress of firms (G33) |
| Financial distress of firms (G33) | Financial collapse (G01) |
| Temporary financing (G32) | Mitigation of liquidity issues (G33) |
| Temporary financing (G32) | Prevention of insolvency (G33) |
| Vulnerability to short-term foreign currency exposure (F31) | Need for preventive measures (I32) |