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No. 407: How Much Did Excess Debt Contribute to the 1997 Currency Crisis in Korea?

Duo Qin , Queen Mary and Westfield College, University of London

July 1, 1999

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Abstract

It is widely believed that seriously excess debt problems form a major cause of the 1997 Asian financial crisis. This paper investigates empirically the role of the debt problems with respect to both the won/$US rate fluctuations and the won collapse in November 1997. The problems are represented by two institutional variables in nonlinear equilibrium-correction models. The variables are found to exert positive feedback effects on the won rate returns in three forms: disequilibrium in levels, short-run shocks and explosive bubbles. However, the estimated effects are not so singly conspicuous as to serve as the predictor of a likely crash in the won rate in late 1997. Excess debt is hence found to only constitute one of the many factors which brought about the 1997 won collapse.

J.E.L classification codes: D50, E22, E44, F31, F34, F41, G20, O16, O23, O53

Keywords:Disequilibrium, Currency crisis, Excess debt, Institutional variable, Self-fulfilling effect, Intrinsic bubble, Soft-budget constraint

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