Introduction

Was the Asian crisis caused by fundamental weaknesses and policy mistakes, or was it due to a financial ‘panic’ (encompassing phenomena such as ‘fickle investors’, volatile hot money, multiple instantaneous equilibria, speculative capital flights and bank runs)? An analysis of the causes of the crisis is important because, depending on one's view, conclusions may differ as regards what could have been done differently to prevent the crisis and its global contagion, and what can be done in the future to reduce the risk of financial turmoil.

Yet, the two ‘views’ of the crisis are not completely inconsistent with each other. On the one hand, the possibility of multiple instantaneous equilibria – underlying interpretations based on self-fulfilling attacks – arises only when economic fundamentals are ‘weak enough’ – i.e. some deterioration of fundamentals is a necessary condition preceding a panic. On the other hand, the view that the crisis is initially triggered by fundamental factors does not necessarily rule out the possibility that, after the crisis, movements of asset prices (exchange rates and stock market indexes) and capital flow reversals may be excessive and not warranted by fundamentals.

Challenging the readings of the 1997–8 events that downplay the role of structural factors, in the first part of this chapter we attempt to document the extent to which the Asian crisis was related to fundamental imbalances. We argue that, beneath apparently strong economic performances (low budget deficits, low public debt/GDP ratios, single-digit inflation rates, high economic growth and high savings and investment rates) lay institutional weaknesses, policy inconsistencies and severe structural distortions.