The Asian Disease: Plausible Diagnoses, Possible Remedies

Abstract

The Asian crisis is a textbook case of the "financial instability hypothesis " first expressed in 1966 by the late Hyman Minsky. It began with what Minsky described as "the economics of euphoria:...The confident expectation of a steady stream of prosperity gross profits [produces a] willingness...to take what would have been considered in earlier times undesirable chances in order to finance the acquisition of additional capital goods... Those that supply financial resources live in the same expectational climate as those that demand them... An essential aspect of a euphoric economy is the construction of liability structures which imply payments that are closely articulated... to cash flows due to income production... Withdrawals on the supply side of financial markets may force demanding units that were under no special strain and were not directly affected by financial stringencies to look for new financing connections. An initial disturbance can cumulate through such third-party or innocent-partry bystanders... Financial instability occurs whenever a large number of units resort to extraordinary sources for cash. " 1 Minsky's "hypothesis " was proposed to explain instability in a large, insulated, developed economy. Despite its intuitive appeal, it was not widely accepted among financial economists (Charles Kindleberger being a notable exception 2) because, they said, they could not find historical illustrations to fit the theory. The financial economist's machine runs smoothly in the best of all possible worlds. The Capital Assets Pricing Model