Bailouts, Taxation and Financial Supervision

Two hypotheses are usually advanced to explain the East Asian twin financial and exchange rate crises in 1990's. The first, stresses market failure, namely the sudden shift in market sentiment that rapidly propagated itself regionally and which lead to financial turmoil. According to this view, market turmoil was more severe due to the policies of financial-market deregulation and of capital-account liberalisation in the affected economies. The second, focuses instead on government failure, primarily at the macroeconomic level. Common to both hypotheses, however, is the view that financial system fragility resulted from the interaction of both structural microeconomic problems and inappropriate macroeconomic policies. This observation accords with Diaz-Alejandro's (1985) interpretation of the 1981-1983 Chilean crisis, which illustrates the dangers of financial reforms under fixed but adjustable exchange rates, free international capital flows, implicit guarantees of bank deposits and weak financial supervisory systems