The 2008 Financial Crisis and Potential Output in Asia : Impact and Policy Implications

Monitoring the behavior of potential output helps policymakers implement appropriate policies in response to an economic crisis. In the short-run, estimates of the output gap will guide the timing of implementation and withdrawal of stimulus measures. In the medium- to long-term, these estimates will also provide the basis for gauging productive potential and hence guide policies to support the sustainable non-inflationary output growth. In this paper, we investigate the post-crisis behavior of potential output in emerging East Asian economies, by employing the Markov-switching model to account for structural breaks. Results show that after the 1997/98 Asian financial crisis, potential output in Hong Kong, China; Korea; Singapore; and Malaysia reverts to the level consistent with the trend prior to the crisis. While there is a permanent drop in potential output in Thailand and Indonesia, growth rates returned to the pre-crisis trend. PRC, Taipei,China, and the Philippines are special cases. Econometric estimates of a simple growth model show that the difference among economies can be attributed to the investment-GDP ratio, macroeconomic policies, exchange rate behavior, and productivity which is proxied by the level of technological activity. These results can guide policy after the 2008 crisis.