U.S. and Taiwan (2009)

Board of Governors of the Federal Reserve System

Chairman Ben S. Bernanke
At the Federal Reserve Bank of San Francisco's Conference on Asia and the Global Financial Crisis, Santa Barbara, California
October 19, 2009

Asia and the Global Financial Crisis

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 tigers¹, and subsequently by China taking a prominent place on the world economic stage. 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.

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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.

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Transmission Channels: Trade and Finance

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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.

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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 non-Asian 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.

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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.

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Footnotes

1. The term "Asian tigers" refers to the economies of Hong Kong, Singapore, South Korea, and Taiwan. Return to text

2. This estimate is based on purchasing power parity measures of GDP. Return to text

3. The Asian region here refers to Australia, China, Hong Kong, India, Indonesia, Japan, Malaysia, New Zealand, Pakistan, the Philippines, Singapore, South Korea, Taiwan, Thailand, and Vietnam. The economic growth calculation weights these economies by GDP at market exchange rates. Return to text

4. These growth rates are measured on a quarter-to-quarter basis at an annual rate. China's quarterly growth rate is estimated from published four-quarter growth rates. Return to text

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6. Specifically, the vertical axis shows each country's deviation of average GDP growth from trend growth (at an annual rate) over 2008:Q4 and 2009:Q1. Trend growth is defined as the average annualized growth rate during 2006 and 2007 of historical GDP data smoothed using the Hodrick-Prescott filter. The horizontal axis shows each country's trade openness as measured by the sum of its imports and exports as a fraction of its nominal GDP in 2007. Return to text

7. A country's international assets are claims on foreigners by its residents, and liabilities are foreigners' claims on the country's residents. Data on these claims are from Haver and the U.S. Bureau of Economic Analysis. Return to text

8. Whether the relationship shown in Exhibit 3 is causal is not entirely clear, however, as economies that are more exposed to the global financial system also tend to be those economies most open to trade, as can be seen by comparing Exhibit 3 to Exhibit 2. Return to text

9. The data are quarterly through the second quarter of 2009. Exports are measured in U.S. dollars. Return to text

10. In principle, some rebuilding of inventories for export could also be boosting production, but such inventory data for the region that are available do not strongly support this view. Return to text

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Exhibit 2. Trade Openness and GDP Growth (2008Q4-2009Q1)

Asia

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Country: Taiwan
Growth Relative to Trend*: -17.60
Trade Openness**: 1.18

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* Growth relative to trend is the percentage point difference between the realized rate of growth during 2008Q4 and 2009Q1, measured at an annual rate, and trend growth. Trend growth is the average annualized growth rate during 2006 and 2007 of smoothed gross domestic product (GDP) using the Hodrick-Prescott filter.

** (Exports+Imports) / GDP in 2007.

Source: CEIC, Haver, and staff estimates.

Exhibit 3. Financial Openness and GDP Growth (2008Q4-2009Q1)

Asia

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Country: Taiwan
Growth Relative to Trend*: -17.60
Financial Openness**: 3.26

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* Growth relative to trend is the percentage point difference between the realized rate of growth during 2008Q4 and 2009Q1, measured at an annual rate, and trend growth. Trend growth is the average annualized growth rate during 2006 and 2007 of smoothed gross domestic product (GDP) using the Hodrick-Prescott filter. Return to table

** (International Assets+Liabilities) / GDP in 2007. Return to table

Source: CEIC, Haver, and staff estimates. International investment position data are from Haver and the U.S. Bureau of Economic Analysis.

Exhibit 4. Asian Industrial Production and Exports Relative to Pre-Crisis Peak

Ratio

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Country: Taiwan
Industrial Production: 0.81
Exports*: 0.77

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* Exports are measured in U.S. dollars. Industrial production and export data are through the second quarter. Return to table

Source: CEIC, Haver, and staff estimates.