benoit cœure : lessons from east asia for the euro area speech by mr benoit cœure, member of the executive board of the european central bank, at the asia europe economic forum on “ challenges and prospects for asian and european economies ”, beijing, 28 october 2013. * * * i would like to thank ine van robays for her contribution. i remain solely responsible for the opinions contained herein. ladies and gentlemen, the global economic and financial crisis confronted the world economy not only with financial turbulence, loss in output and social distress on a scale not seen since the great depression. it also created a series of challenges for policy - makers. across the euro area, it exposed structural and institutional weaknesses that had remained hidden during the preceding era, the “ great moderation ”. times of crisis are times of hardship – but they are also times of change and opportunity. this seems particularly true for europe, where progress has often come in this way. the second world war was the impetus for the european coal and steel community, which was established to prevent another war between france and germany. it formed the nucleus of today ’ s european union. the demise of the bretton woods system in the 1970s was the catalyst for a european single currency, which was eventually introduced in 1999. i ’ ll be talking today about the effects of the present crisis and the various challenges it has presented for the euro area. i ’ ll compare it with the east asian crisis of 1997. in my view, there are similarities that yield useful policy lessons for the euro area. but there are also differences that need to be kept in mind. what can we learn from the asian crisis? what are the parallels between the asian crisis in 1997 – 1998 and the euro area crisis? the economies of emerging asia were characterised by buoyant growth and a brisk expansion of credit ( see chart 1 ). this rise in debt was facilitated by considerable inflows of foreign capital, which financed significant external deficits ( see chart 2 ). this led to growing financial imbalances, and in particular to currency and maturity mismatches on the balance sheets of local banks. in addition, the economic boom prevailing at that time was accompanied by a loss of competitiveness of the region ’ s export sector. investors typically under - priced potential risks as they had overly optimistic expectations of the medium - term growth prospects. they did not identify systemic vulnerabilities such as the risk of sudden stops in capital flows or of twin

crises of the banking system and the balance of payments, which eventually materialised. 1 except for currency mismatches, similar developments were evident in the euro area before 2009 – if not at the regional level, at least in those countries that later ran into financial difficulties. it was widely believed that sudden stops in capital flows, not to mention twin see calvo, g. ( 1998 ). “ capital flows and capital - market crises : the simple economics of sudden stops ”, journal of applied economics 1 ( 1 ), pp. 35 – 54, and kaminsky, g. and c. reinhart ( 1999 ). “ the twin crises : causes of banking and balance - of - payments problems ”, american economic review, 89, pp. 473 – 500. a well known example of complacency about east asian growth is the 1993 world bank report on “ the east asian miracle ”. bis central bankers ’ speeches banking and balance of payments crises, could not happen in advanced economies. 2 and yet this is exactly what happened in europe ten years after the asian crisis ( see chart 2 ). it seems therefore useful to look also at east asia ’ s response to its crisis and see what lessons can be learned. one lesson is that a deep and fundamental restructuring of the domestic financial sector is necessary given the financial nature of the asian crisis, this was a key element in resolving it. nonviable financial institutions were closed, viable institutions recapitalised and strengthened, value - impaired assets dealt with and the corporate sector restructured, including through foreign investment. 3 these measures were implemented decisively. they were associated with a painful adjustment process in the crisis countries but, at the same time, they made a swift recovery possible. this experience contrasts with japan ’ s experience in the late 1980s. following the bursting of japan ’ s asset bubble, there was by and large no rapid write - down of non - performing assets. due to the low profitability of banks, it was believed that an immediate write - off of bad loans would prevent compliance with capital requirements. the recognition of losses was postponed and, as a consequence, capital continued to be allocated to investments with limited positive impact on japan ’ s long - term growth potential, which some have called “ zombie lending ” 4. ultimately, this resulted in japan ’ s “ lost decade ”, namely an extended period of anaemic growth ( see chart 3 ). a second lesson is that institutional and structural reforms are essential