Ben S Bernanke: Asia and the global financial crisis
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, at the Federal Reserve Bank of San Francisco's Conference on Asia and
the Global Financial Crisis, Santa Barbara, California, 19 October 2009.
* * *
The rise of the Asian economies since World War II has been one of the great success
stories in the history of economic development. Japan's transition to an economic
powerhouse was followed by the rapid ascent of the Asian tigers, and subsequently by China
taking a prominent place on the world economic stage.1 Since the beginning of this decade,
Asia has accounted for more than one-third of the world's economic growth, raising its share
of global gross domestic product (GDP) from 28 percent to 32 percent.2 Importantly, its
economic success has resulted in large-scale reductions in poverty and substantial
improvements in the standards of living of hundreds of millions of people. China and India,
which together account for almost 40 percent of the world's population, have seen real per
capita incomes rise more than 10-fold and 3-fold, respectively, since 1980. As would be
expected given the increasing size and sophistication of their economies, the nations of the
region have also begun to exert a substantial influence on global economic developments
and on international governance in the economic and financial spheres.
It is widely agreed that a key source of Asia's rapid advancement has been the openness of
countries in the region to global trade and finance. Notwithstanding this consensus, the
considerable progress of these countries in developing domestic institutions, policies, and
industrial capacity - together with their strong growth in the initial phase of the ongoing global
financial crisis - led some to speculate that the Asian economies had "decoupled" from the
advanced economies of North America and Europe. Of course, in hindsight, given the
magnitude of the shocks that have struck these advanced economies over the past two
years, as well as their strong economic and financial links to Asia, it should not have been
surprising that Asia was ultimately hit quite hard by the global downturn, even though the
origins of the turmoil were elsewhere.
As a prelude to the papers and discussions to follow, I will provide a brief overview of the
Asian experience during the global financial crisis. I will highlight the diversity of experiences,
both within Asia and between Asia and other regions, and draw some inferences about the
different channels through which the effects of the financial crisis were transmitted around
the world. I will discuss Asia's policy response to the economic and financial consequences
of the crisis. Finally, I will focus on medium-term challenges. For both Asia and the United
States, perhaps the greatest medium-term challenge is to achieve more balanced growth
and, in the process, to further reduce global imbalances.
Asia's experience in the crisis
During the years following the financial crisis of the late 1990s, many emerging market
economies, in Asia and elsewhere, took advantage of relatively good global economic
conditions to strengthen their economic and financial fundamentals; they improved their fiscal
and external debt positions, built foreign exchange reserves, and reformed their banking
sectors. Hence, at the onset of the financial turmoil in the summer of 2007, the Asian
economies appeared well-positioned to avoid its worst effects. Although global financial
markets, including Asian markets, deteriorated sharply following the start of the crisis, Asia's
recovered swiftly, with equity prices reaching new highs early in the fourth quarter of that
year. Moreover, economic activity in the region continued to expand.
However, toward the end of 2007, at about the same time that the United States entered a
recession, the headwinds facing the Asian economies appeared to strengthen. Asian equity
markets began to fall again - they were to underperform global markets throughout much of
2008 - and other signs of financial stress, such as widening credit spreads, appeared as
well. By the second quarter of 2008, many of the region's economies were slowing, and
growth in Hong Kong, Singapore, and Taiwan - small, open economies particularly sensitive
to shifts in global conditions - had ground to a halt.
In September and October 2008, as you know, the global financial crisis intensified
dramatically. Concerted international action prevented a global financial meltdown, but the
effects of the crisis on asset prices, credit availability, and consumer and business
confidence resulted in sharp declines in demand and production worldwide. Reflecting this
worsening economic climate, Asian GDP growth slowed further in the second half of 2008.
For the region as a whole, the economic contraction in the fourth quarter of 2008 was
pronounced, with activity falling at an annual rate of nearly 7 percent.3 The fourth-quarter
declines were especially dramatic in Taiwan and Thailand (more than 20 percent at an
annual rate) and in South Korea and Singapore (more than 15 percent at an annual rate).
Among the major Asian economies, only those of China, India, and Indonesia did not
contract during the crisis.
Early this year, with many of the Asian economies in freefall, a quick recovery seemed
difficult to imagine, but recent data from the region suggest that a strong rebound is, in fact,
under way. Although the regional economy continued to contract in the first months of 2009,
it expanded at an impressive 9 percent annual rate in the second quarter, with annualized
growth rates well into double digits in China, Hong Kong, Korea, Malaysia, Singapore, and
Taiwan.4 At this point, while risks to the economic outlook certainly remain, Asia appears to
be leading the global recovery.
Diversity of experiences
This brief review of Asia's experience during the crisis raises a number of important
questions: Through what channels were the effects of the financial crisis transmitted across
the globe? In particular, why was Asia, whose financial systems largely escaped the serious
credit problems that erupted in the United States and Europe, hit so hard by the global
recession? What enabled the Asian economies to bounce back so sharply more recently?
And why did some countries - around the world and within Asia - suffer much deeper
contractions than others? Some light can be shed on these questions by examining the
diversity of experiences among both Asian and non-Asian economies during the downturn.
Transmission channels: trade and finance
The crisis that began in the West affected Asia through various transmission channels,
whose relative importance depended in some degree on the particular characteristics of each
economy. However, for virtually all of the Asian economies, international trade appears to
have been a critical channel. Exhibit 1 shows the course of global merchandise exports since
the beginning of this decade. As the exhibit shows, after a period of strong growth,
international trade plunged about 20 percent in real terms from its pre-crisis peak to its
trough in early 2009 (the dashed red line), and about 35 percent in U.S. dollar terms (the
solid blue line).5 The trade-dependent economies of Asia could certainly not be immune to
the effects of such a decline.
Why did global trade fall so abruptly? The severe recession in the advanced economies
greatly restrained aggregate spending, including spending on imports, but the decline in
international trade appears surprisingly large even when the depth of the recession in the
advanced countries is taken into account. One possible explanation for the outsized decline
in trade volumes lies in the extreme uncertainty that prevailed in the darkest months of the
crisis. Consumers and businesses knew last fall that economic conditions were poor, but, in
light of the severity and the global nature of the financial crisis, many feared outcomes that
might be much worse. Perhaps to a greater extent than they might have otherwise,
households and firms put off purchases of big-ticket items, such as consumer durables and
investment goods. Durable goods figure prominently in trade and manufacturing, so these
sectors may have been particularly vulnerable to the elevated uncertainty and weakened
confidence that prevailed during the height of the crisis.
Credit conditions also likely affected the volume of trade, through several channels. The
turmoil in credit markets doubtless exacerbated the sharp decline in demand for durable
goods, and thus in trade volumes, as purchases of durable goods typically involve some
extension of credit. Manufacturing production, a major component of trade flows, may have
been cut back more sharply than would otherwise have been the case as producers,
concerned about credit availability, attempted to preserve working capital. Finally, although it
is difficult to assess the size of the effect, problems in obtaining trade finance may have also
impeded trade for a time.
With trade falling sharply around the world, economies particularly dependent on trade were
hit especially hard. Exhibit 2 illustrates this point for a group of Asian and non-Asian
economies. The vertical axis of the figure shows real GDP growth, measured relative to
trend, during the most severe stage of the downturn, and the horizontal axis shows a
measure of openness to trade.6 Combinations of growth and openness observed in various
economies are indicated by red squares for a number of Asian countries and by black dots
for several non-Asian countries. The exhibit shows that countries most open to trade (those
located further to the right in the figure) suffered, on average, the greatest declines in growth
relative to trend. The most extreme cases are Hong Kong and Singapore, shown to the far
right; the economies of Korea, Taiwan, Thailand, and Malaysia, which are also very open,
suffered significant growth deficits as well.
Indeed, the GDP contractions in some Asian economies during that period rivaled those
during the Asian financial crisis of the late 1990s. Relative to pre-crisis trend, the six Asian
economies just mentioned plus Japan experienced declines in real GDP growth of about 13
to 20 percentage points at an annual rate during the last quarter of 2008 and the first quarter
of 2009. Growth fell somewhat less severely in the Philippines and only moderately in
Australia and New Zealand. As noted earlier, real GDP growth remained positive throughout
the crisis in China, India, and Indonesia, but, as exhibit 2 shows, even those fast-growing
economies experienced noticeable declines in growth relative to their earlier trends. The
exhibit shows that a similar relationship between growth and openness to trade holds for
non-Asian countries; for example, more trade-dependent nations like Germany saw sharper
declines in output during the crisis than other less-open economies.
Variations across countries in trade openness do not fully explain the diversity of growth
experiences during the downturn, suggesting that other factors were also at work. Notably,
although financial institutions in emerging market economies were not, for the most part,
directly affected by the collapse of the market for structured credit products and other
assetbacked securities, financial stress nevertheless affected these countries. As international
investors' appetite for risk evaporated, the flow of capital shifted away from countries that had
historically been viewed as more vulnerable, including some emerging Asian and Latin
American economies, even though many of these countries appeared to be much better
positioned to weather an economic crisis than in the past. Moreover, regardless of perceived
risks, financial institutions pulled money from risky assets in advanced and emerging markets
alike in an effort to strengthen their balance sheets.
Following the reversal in capital flows engendered by the crisis, strains in banking appeared
across Asia, leading to severe credit tightening in some countries. Fears of counterparty risk
disrupted interbank lending in many countries, intensifying already existing funding
difficulties. The drying up of the wholesale funding market hurt Korea's banking system in
particular; prior to the crisis, it had accounted for about one-third of Korean bank funding. In
Japan, some banks' exposures to equity markets damaged their capital positions. With Asian
banks experiencing dollar funding pressures similar to those arising elsewhere in the world,
the Federal Reserve established 5 of its 14 liquidity swap lines with central banks in the
region: Australia, Japan, Korea, New Zealand, and Singapore. The reversal in capital flows
also caused rapid exchange rate depreciation in some countries, particularly Korea,
Indonesia, and Malaysia. The Korean won depreciated 40 percent against the dollar from the
beginning of 2008 through its trough in March of this year, and it has only partially recovered.
Over the same period, the Indonesian rupiah fell 22 percent against the dollar.
Exhibit 3 shows the relationship between rates of GDP growth during the downturn, relative
to trend, and financial openness, as measured by the sum of each country's international
assets and liabilities relative to its GDP.7 The exhibit shows that, for both Asian and
nonAsian economies, financial openness was associated with greater declines in output, though
the linkage appears somewhat less tight than that for trade.8 Again, the most extreme cases
are Singapore and especially Hong Kong (which is not shown, as it is more than twice as
open as even Singapore). Taiwan is another example of a financially open Asian economy
that experienced a particularly severe downturn. By the same token, China, India, and
Indonesia, the three Asian countries in which output expanded throughout the crisis, are
among the least financially open.
Trade and financial channels influenced other emerging markets as well, such as those in
Latin America and Eastern Europe. Many of these economies also contracted sharply, but
thus far they have recovered more slowly than economies in Asia. In the case of Latin
America, closer links to the U.S. economy (especially in the case of Mexico) and greater
dependence on commodity exports (whose prices declined during the most intense phase of
the crisis) were additional sources of weakness. In Eastern Europe, preexisting
macroeconomic imbalances and structural weaknesses likely magnified the effects of the
adverse global shocks.
It is important not to take the wrong lesson from the finding that more open economies were
more severely affected by the global recession. Although tighter integration with the global
economy naturally increases vulnerability to global economic shocks, considerable evidence
suggests that openness also promotes stronger economic growth over the longer term.
Protectionism and the erecting of barriers to capital flows should thus be strongly resisted.
Instead, as I will discuss, striking a reasonable balance between trade and growth in
domestic demand is the best strategy for driving economic expansion.
Policy responses
By and large, countries in Asia came into the crisis with fairly strong macroeconomic
fundamentals, including low inflation and favorable fiscal and current account positions.
Good fundamentals, in turn, provided scope for strong policy responses in many countries.
China, Japan, Korea, and Singapore were among those employing relatively aggressive
policy strategies; in particular, China undertook a sizable fiscal program, supplemented by
accommodative monetary and bank lending policies. The stimulus packages in China and
elsewhere have lifted domestic demand throughout the region, boosting intraregional trade.
Not all Asian nations responded so aggressively to the crisis. Some countries with weaker
fiscal positions no doubt felt constrained in the extent of fiscal stimulus they provided.
Similarly, monetary policies were likely influenced by differences in inflation performance. On
the one hand, countries experiencing low inflation or deflation, such as China, Japan, and
Thailand, were able to implement expansionary monetary policies without concerns about
increasing inflationary pressures. Indeed, Japan used unconventional monetary easing in
part to avoid deeper deflation. On the other hand, inflation concerns were more pressing for
Indonesia, the Philippines, and Korea, with the result that their monetary policy responses
may have been more muted than would otherwise have been the case. The national
variation in policy responses likely also reflected differences in the severity of the crisis
across countries.
Generally speaking, the Asian response to the crisis appears thus far to have been effective.
Importantly, as I have suggested, the Asian recovery to date has been in significant part the
result of growth in domestic demand, supported by fiscal and monetary policies, rather than
of growth in demand from trading partners outside the region. To illustrate the point, for each
of the countries in the region, exhibit 4 shows industrial production (the solid blue bars) and
exports (the striped red bars) measured relative to the pre-crisis peak.9 You can see that the
blue bars are generally taller than the red bars, indicating that, except for New Zealand and
Hong Kong, industrial production has rebounded by more than exports. Indeed, industrial
production in China, India, and Indonesia has already reached new highs, and it is within
about 5 percent of its previous peak in Australia and Korea. We would expect to see this
pattern if growth in domestic demand, rather than growth in exports, was the predominant
driver of increases in domestic production.10 The revival of demand in Asia has, in turn, aided
global economic growth.
Despite the initial successes of Asian economic policies, risks remain. As in the advanced
economies, unwinding the stimulative policies introduced during the crisis will require careful
judgment. Policymakers will have to balance the risks of withdrawing policy support too early,
which might cut short a nascent recovery, against the risks of leaving expansionary policies
in place for too long, which could overheat the economy or worsen longer-term fiscal
imbalances. In Asia, as in the rest of the world, the provision of adequate short-term stimulus
must not be allowed to detract from longer-term goals, such as the amelioration of excessive
global imbalances or ongoing structural reforms to increase productivity and support
balanced and sustainable growth.
Lessons from crises and medium-term challenges
For now, Asian countries look to be weathering the current storm. In part, their successful
responses reflect the lessons learned during the Asian financial crisis of the 1990s, including
the need for sound macroeconomic fundamentals.
One crucial lesson from both that crisis and the recent one is that financial institutions must
be carefully regulated, transparent, and sufficiently well capitalized and liquid to withstand
large shocks. In part because of the reforms put in place after the crisis of the 1990s, along
with improved macroeconomic policies, Asian banking systems were better positioned to
handle the more recent turmoil. With the increased prominence of the Group of Twenty
(G-20) as a forum for discussing the global responses to the crisis, emerging market
economies, including those in Asia, will play a larger role in the remaking of the international
financial system and financial regulation.
Another set of lessons that Asian economies took from the crisis of the 1990s may be more
problematic. Because strong export markets helped Asia recover from that crisis, and
because many countries in the region were badly hurt by sharp reversals in capital flows, the
crisis strengthened Asia's commitment to export-led growth, backed up with large current
account surpluses and mounting foreign exchange reserves. In many respects, that model
has served Asia well, contributing to the rapid growth rates in the region over the past
decade. In fact, it bears repeating that evidence from the world over shows trade openness
to be an important source of economic growth. However, too great a reliance on external
demand can also pose problems. In particular, trade surpluses achieved through policies that
artificially enhance incentives for domestic saving and the production of export goods distort
the mix of domestic industries and the allocation of resources, resulting in an economy that is
less able to meet the needs of its own citizens in the longer term.
To achieve more balanced and durable economic growth and to reduce the risks of financial
instability, we must avoid ever-increasing and unsustainable imbalances in trade and capital
flows. External imbalances have already narrowed substantially as a consequence of the
crisis, as reduced income and wealth and tighter credit have led households in the United
States and other advanced industrial countries to save more and spend less, including on
imported goods. Together with lower oil prices and reduced business investment, these
changes in behavior have lowered the U.S. current account deficit from about 5 percent of
GDP in 2008 to less than 3 percent in the second quarter of this year. Reflecting in part
reduced import demand from the United States, China's current account surplus fell from
about 10 percent of GDP in the first half of 2008 to about 6-1/2 percent of GDP in the first
half of this year.
As the global economy recovers and trade volumes rebound, however, global imbalances
may reassert themselves. As national leaders have emphasized in recent meetings of the
G-20, policymakers around the world must guard against such an outcome. We understand,
at least in principle, how to do this. The United States must increase its national saving rate.
Although we should deploy, as best we can, tools to increase private saving, the most
effective way to accomplish this goal is by establishing a sustainable fiscal trajectory,
anchored by a clear commitment to substantially reduce federal deficits over time. For their
part, to achieve balanced and sustainable growth, the authorities in surplus countries,
including most Asian economies, must act to narrow the gap between saving and investment
and to raise domestic demand. In large part, such actions should focus on boosting
consumption. Admittedly, just as increasing private saving in the United States is
challenging, promoting consumption in a high-saving country is not necessarily
straightforward. One potentially effective strategy is to reduce households' precautionary
motive for saving by strengthening pension systems and increasing government spending on
health care and education. Of course, such measures are likely to improve welfare and
productivity as well as to contribute to more balanced, robust, and sustainable economic
growth.
Conclusion
The United States has benefited significantly from Asia's rapid development and integration
into the global economy, and the payoffs to the Asian economies from global economic
integration have been substantial as well. Indeed, the financial crisis has starkly
demonstrated the extent to which the fortunes of the United States, Asia, and the rest of the
global economy are intertwined. These powerful economic linkages, as well as the
importance of both the United States and Asia in the global economy, underscore the need
for consultation and cooperation in addressing common issues and concerns. Our shared
stakes in the prospects of the global economy bring with them a heightened responsibility to
work together to maintain those prospects. I am optimistic that the United States and Asia
will rise to the challenge and address in a mutually beneficial fashion the range of issues
confronting the global economy. Conferences such as this one, which bring together
policymakers and scholars from both sides of the Pacific, will further the cause of this
cooperation.
BIS Review 128/2009
BIS Review 128/2009