Interview with Timothy F Geithner: Asia After the Crisis: What Now, What’s Next?

ETHOS Issue 03, Oct 2007

You were very much involved in trying to resolve the Asian Financial Crisis. Ten years on, with the benefit of hindsight, is there anything you would have done differently, in terms of international financial institutions and governments?

This is a hard question to answer because the right test to policy is based on what you could know then, not what you know now. Of course, it is very important to recognise that most of what made the crisis traumatic and damaging were decisions made before the crisis and the conditions that existed at that point. Those conditions gave governments very poor options. Most of what made the crisis traumatic was the size of the balancing problem and the constraints on how some policymakers could react.

One way to see this is to contrast the Malaysian experience with those of many other crisis countries—Singapore being an exception. Malaysia had been through an earlier crisis in the banking system and had largely cleaned that up. For this and other reasons, they entered that period of crisis in 1997 with a much stronger balance sheet and much less vulnerability.

Given the initial environment, it would have been very hard at the time for governments at that point to have done much to mitigate the crisis. Of course, if there had not been an election in Korea, political uncertainty in Thailand and a succession crisis in Indonesia, and if the governments had, at that point, put in place the set of policies they ultimately adopted three, six or even nine months later, the crisis might have been less damaging. But those are conditions that they probably could not have pushed for.

Given that the pre-existing conditions determined the magnitude of the crisis, could more have been done to prevent it, such as through increased surveillance and other measures by international financial institutions?

No, these conditions were essentially the consequences of choices made by governments, and I do not believe you can expect to live in a world where governments will agree to constrain their sovereignty—in a way that will give an international organisation, such as the International Monetary Fund, the mandate to influence the country’s exchange policies ahead of a crisis. It is a good idea for countries to be exposed to a system where you can have a second pair of eyes or alternative points of view and good advice to call on. But it would not be realistic to design an international surveillance regime that could make a substantial contribution to crisis prevention on this scale.

Nevertheless, Asian countries have generally learnt the right lessons in the dramatic policy moves they have made since the crisis. You could argue that the focus on foreign reserve accumulation is not the most compelling defence against crisis. In some ways, it is a reflection of market distortions and a lack of options, but you cannot but conclude that this policy has been very effective in addressing the set of initial vulnerabilities in a crisis that had been so traumatic.

It is one thing for governments to have dealt with the conditions that led to this Asian financial crisis, but are they sufficiently prepared for the next crisis to come, one that could be very different in nature?

The thing about crises is that the causes are largely unanticipated factors and the vulnerabilities are not the ones you can identify ex ante. This is a natural feature of markets. It is important to acknowledge that a lot of mature industrial countries with much more developed banking systems, financial systems, supervisory systems and government frameworks also go through periods of stress and financial crises. For some countries, such as Japan in the late 80s, or in parts of Scandinavia before that, there had been very challenging systemic financial crises even though they did not enter a period with the type of acute balancing vulnerability found in Asia.

The basic policy prescription is relatively straightforward: make sure fiscal policy is reasonably prudent; monetary policy has the flexibility and independence to address threats to price stability and sustainable growth; the banking systems have strong enough cushions; and moral hazard does not destroy incentives so that the financial system can absorb much more volatility. Overall, of course, you want an economy that is flexible enough to absorb shocks.

There are two basic options for dealing with a world with a more open capital account. One is to insulate the economy from constrained volatility. Another is to prepare to live with it more freely and comfortably. Often this is the only viable path for very open economies like what you see in Asia in general.

In your view, what is the new role of monetary policy, particularly in the face of asset price volatility and the disinflation effect of China prices?

The academic consensus on the China effect is not very well developed. Some would say that the impact of this huge increase in the global oversupply is going to provide a sustained downward pressure on manufacturing goods and prices and so on. Others argue that this huge increase in demand for commodities could result in a completely different net effect.

In contrast, Wisconsin eschewed training and emphasised work instead,9 since it was found that work experience proved to be far more valuable than the additional retooling individuals would receive had they chosen instead to receive training first. Furthermore, programmes that focused on work over training were regarded to be a more efficient use of resources.

I think now that you see more pressure on resources and on goods inflation in a place like China, there may be early signs that the disinflation effect may be diminishing.

The broader impact on monetary policy in general is more complicated. I think countries that are still trying to tightly manage the volatility of the exchange rate—particularly those that are more closely integrated with the United States and China—face a risk that over time, it will become harder to sustain that commitment to exchange rate stability with a commitment to price stability. In much of Asia, you don’t really have that pure combination of an independent central bank with a clear price stability mandate. The typical construct in Asia is a more mixed model where you have a much more closely managed exchange rate, and central banks with a range of different objectives and not fully independent.

In terms of asset price volatility in the world of price stability, the overwhelming consensus among academics and central bankers now is that if you get the monetary policy wrong, you could amplify the volatility of asset bubbles. You might make the bubbles worse and you might make it harder for monetary policies to cushion the effects of the bubble.

In some ways, the definition of a good monetary policy means that you can’t effectively use monetary policy to defuse these potential bubbles ex ante. There are two arguments for this: One is that you don’t really know about asset price bubbles until after the fact. Even if they look obvious in the present, you can’t tell for sure whether they are in the early stages. You don’t know the scale of the mispricing. The second argument is that monetary policy could act to defuse the bubbles but the damage it might cost might not be worth the benefit.

Singapore was an early globaliser and this has benefited all segments of society. Yet the fruits of economic growth brought about by globalisation are becoming much more unevenly distributed now than before. What do you think is the role of fiscal policy in helping economies adjust to the inequitable distribution of economic growth?

This is a challenge common to countries both rich and less rich. The consensus in the US is to look less at fiscal policy as the solution to that problem and to look more to areas where Singapore is already exceptionally good, such as improving the evenness and the quality of educational outcomes, as well as adapting important features of the safety net, particularly in terms of health insurance and pension funds. The approach is to make people more comfortable living in a world where they’re going to change jobs many different times, where they must face more uncertainties and more anxieties about the stability of the economic future. Of course, you have to finance these things and there is going to be rich debate on the optimal ways to finance these measures over time.

The US has had a long period of expansion, relatively low unemployment, and good average increase in incomes. Our demographic trends are a little bit later than in many countries. Our initial fiscal stances also give us a bit more room to manoeuvre. As a result, there hasn’t been enough pressure yet to force political resolution over these kinds of challenges. You see the beginnings now of a necessary debate over evolution of the tax regime, health insurance and social security, but we’re at the early stages on these issues.

One of the nice things about central banks, even a central bank like ours that does many different things besides monetary policy, is that our responsibility ends before fiscal policy, education and healthcare and all these other areas.

That said, we are not quite the same as the more common and classic central banking system which leaves the central bank with only monetary policy and takes everything else out. We’re more like Singapore in the sense that we do broader surveillance and other functions. I think that a more integrated model is a better model and a more comfortable model. The broader question about integration with fiscal and monetary policy is a complicated one.

I have to say I look at many aspects of your system with a lot of envy, because you have an exceptionally meritocratic, high quality civil service and the capacity to do things with public policy that governments have to do. Hopefully, our own policy system will be up to the challenge in the future.