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Chapter

II. Recessions and Recoveries in Asia: What Can the Past Teach Us about the Present Recession?

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
May 2009
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Asia is in the midst of a major downturn. With external demand for Asia’s products vanishing as a result of a sharp deleveraging in advanced economies, export and industrial production growth in the region have plunged to levels unimaginable a year ago. In turn, weakness in exports is spilling over to domestic demand, with investment in particular showing signs of declining at a high rate. As such, it is no surprise that both the IMF and other forecasters now expect large contractions in GDP for 2009 in many of the region’s economies.

In this context, two key questions emerge: how long and deep is the current recession likely to be, and how vigorous the recovery? The purpose of this chapter is to look at past recessions and recoveries in Asia to shed light on these important questions.4 In particular, we look at past episodes and assess how long and deep the typical recession has been, why some recessions have been noticeably longer and deeper, if and why some countries within Asia have suffered deeper recessions than others, how strong or weak have recoveries typically been, and what leads these recoveries.

The key findings of the chapter can be summarized as follows:

  • Recessions accompanied by financial stress, notably stress in domestic banking sectors, are substantially longer and deeper than the norm. The fall in credit deprives corporates of working capital and households of the means to smooth consumption, greatly exacerbating the downturn that may have been under way.

  • Recoveries in Asia have been weak, because they were typically driven by a single engine: exports. In contrast, other emerging economies have tended to experience more vigorous recoveries because of a stronger contribution from domestic demand, notably investment.

  • In Asia, deep recessions have resulted in substantial declines in potential output growth, meaning that their effects are not just cyclical but permanent.

Two lessons from the past thus appear particularly pertinent for the present: Asia should strive to preserve the stability of its financial systems and to rebalance growth toward domestic demand. Strong balance sheet positions have so far allowed Asian banks to provide the credit needed in the face of capital outflows. If, however, their capital buffers were to buckle under the likely increase in nonperforming loans—a possible but not an immediate threat (see Chapter 3 of this Regional Economic Outlook)—or if liquidity constraints and risk aversion led them to curtail credit sharply to preserve this capital, history suggests that the current recession, already among the deepest given the unprecedented size of the external shock, could become substantially worse. Moreover, given the expected weak recovery in the G-2 countries (the euro area and the United States), Asia should not count on exports to rebound rapidly as they did in past recoveries—a slow return to precrisis growth levels looks to be the more likely outcome at this stage. In this context, fiscal and monetary stimuli in the region are welcome to help sustain the recovery. More fundamentally, given the risk that G-2 growth might be less consumption-driven in the medium term, many economies in Asia will need structural reforms such as expansion of social safety nets in order to become less export dependent and sustain healthy growth rates going forward.

The rest of the chapter is structured as follows. The next section explains the methodology used to identify recessions and recoveries, and reviews some of their general characteristics. Then the chapter looks at past recessions in Asia with emphasis on two questions: what distinguishes the most severe recessions, and whether some countries are more vulnerable than others. The following section looks at past recoveries in Asia, showing in particular why they have tended to be weak compared with recoveries in other regions. The following section discusses policy responses and their effects in past recessions, and the last section concludes.

Preliminary Considerations

In a study of recessions and recoveries, the first obvious question is: what type of recession? The academic literature typically distinguishes between classical recessions, which entail a decline in GDP levels, and growth slowdowns, which deal with declines in GDP growth. This chapter focuses on classical recessions, mainly because most economies in the region are expected to experience declines in GDP levels in the current cycle.

Recession episodes are identified through an extension of the “two-quarters-of-negative-growth” rule. As general terminology, a “recession” begins when the level of GDP starts declining after a “peak” and ends when the level of GDP reaches a “trough.” A “recovery” begins when the level of GDP starts rising after the trough and ends when the level of GDP returns to its peak level; an “expansion” lasts until GDP reaches its next peak. (Figure 2.1) The chapter identifies peaks and troughs by means of the Bry-Boschan (1971) algorithm, which has become standard methodology in the study of classical recessions.5 Strictly speaking, the algorithm does not require two consecutive quarters of negative growth after a peak to identify a recession, but it does require GDP growth to be negative over the combined two-quarter period following the peak.

Figure 2.1.Recessions, Recoveries, and Expansions

The chapter also differentiates recessions alongside various dimensions that appear relevant at the current juncture. We define a financial crisis recession as a recession episode associated with a domestic banking crisis as identified in Laeven and Valencia (2008), and/or with higher-than-normal levels in our measure of global financial conditions—the financial stress index for advanced economies used in Cardarelli, Elekdag, and Lall (forthcoming).6 We also differentiate between export recessions, defined as those during which export levels fall by at least 5 percent relative to peak level, and nonexport recessions. One objective of this chapter is to assess whether there are clear differences in length, depth, and dynamics between financial stress and nonfinancial stress recessions, and between export and nonexport recessions.

The sample of recessions identified in this chapter is quite diverse, with one surprising finding: export shocks have been an important but not the main cause of recessions in Asia. Limiting the analysis to the post-1980 period because of rapid changes in economic structure in the region, we identify 33 recessions in our Regional Economic Outlook economies, excluding the current recession ongoing in several of these economies.7 Of these 33 recessions, 10 occurred in industrial Asia—Japan, Australia, and New Zealand—and 23 in emerging Asia (see Table 2A.1 in Appendix 2.1). Of relevance, no classical recession occurred in China or India during the sample period. Seventeen out of the 33 recessions are associated with financial stress, but only 7 of these 17 coincided with a banking crisis. The latter have typically resulted from the bust of large imbalances in the domestic economy, as was the case in Japan in the 1990s or in the Asian crisis. Finally, 8 of the 33 were export recessions according to our definition, suggesting that export shocks have been an important but far from exclusive driver of recessions in the region. Needless to say, the current recession in Asia—which is not included in the study—is, first and foremost, an export recession.

Asia’s business cycles appear increasingly coordinated with global business cycles. The incidence of recessions in Asia has by and large been uncorrelated with the incidence of recessions in advanced economies, either contemporaneously or with lags, when measured over the whole sample (Figure 2.2). At the same time, every U.S. recession has coincided with at least 20 percent of the Asian economies in our sample being in recession, and often more (Figure 2.3). Moreover, the correlation between the incidence of recessions in Asia and globally appears to have increased over the past decade, a possible consequence of Asia’s deepening integration with the global economy.8

Figure 2.2.Recession Timeline since 1980

(Percent of in-sample economies in recession)

Source: IMF staff estimates.

Figure 2.3.Asia and United States: Recession Timeline since 1980

Sources: National Bureau of Economic Research; and IMF staff estimates.

Finally, recessions in Asia have had one common characteristic, regardless of the shock that caused them: investment tends to decline during the recession. Looking across all recessions, exports do not appear to have fallen on average, nor does consumption. Investment, however, falls with high probability (Figure 2.4). Why? The reason has to do with the fact that investment is tied both to exports and to domestic demand, and it suffers when recessions are caused by shocks to export demand, shocks to consumption, or shocks to financial conditions. Indeed, contrary to consumption and exports, investment fell both in the 1997–98 and the 2000–01 recession, which at their roots were very different.

Figure 2.4.Asia: Previous Recessions since 1980

(Median real level, peak of the recessions = 100)
(Median real level, peak of the recessions = 100)
(Median real level, peak of the recessions = 100)

Source: IMF staff estimates.

Recessions in Asia: How Long and Deep?

Are Some Recessions Deeper Than Others?

In Asia, recessions have typically not been very long, nor very deep. The median duration of recessions in Asia has been three quarters, similar to those in advanced economies and other emerging markets. In terms of the cumulative output loss during the recession, Asian episodes have been more costly than those in advanced economies—the median loss during an Asian recession has been around 5 percent of peak GDP, compared with about 3 percent in advanced economies (Figure 2.5). This is consistent with the considerable literature showing that emerging markets are exposed to larger and more persistent volatility than advanced economies,9 owing to the former’s less diversified economic structures and their limited ability to use domestic financial systems or international markets to smooth the impact of shocks. At the same time, recessions in Asia have been less costly than in other emerging markets, where the median cumulative loss has been about 10 percent of peak GDP.10

Figure 2.5.Cumulative Output Loss in Previous Recessions since 1980

(Median, in percent)

Source: IMF staff estimates.

Yet these median statistics mask an important fact: a substantial number of recessions in Asia have been both long and very deep. In particular, 25 percent of recessions in Asia (i.e., 9 of the 33) have lasted longer than a full year, and entailed cumulative output losses larger than 12 percent of peak GDP, more than double the median loss.

These long and deep recessions are all associated with financial stress. Indeed, when we separate our sample between financial stress and nonfinancial stress recessions, the former led to output losses 8 percent of GDP higher in the median. At the same time, it is important to note that not all financial stress matters statistically for the length and depth of recessions. Recessions associated with global financial stress that were not accompanied by a domestic banking crisis are barely different in their severity to recessions with no financial stress, at least in our sample. It is recessions associated with banking crises that are an order of magnitude more severe, entailing a 20 percent of GDP higher median cumulative output loss (Figure 2.6).11 Indeed, the recessions in our sample with the largest 25 percent output losses were all associated with a banking crisis.

Figure 2.6.Asia: Previous Recessions since 1980

(Median)

Source: IMF staff estimates.

Credit curtailment appears to be the channel through which bank impairment amplifies recessions. In the case of Asia, credit growth remains by and large unaffected during standard recessions, but plummets during banking crises. At its lowest point during these recessions, median credit growth is 30 percentage points below its level before the recession started (Figure 2.7). Therefore, firms are deprived of working capital and consumers of the means to smooth consumption, explaining why the two fall substantially more during banking crises. The relationship between credit and the real economy, however, should in no way be seen as unidirectional: banking crises are themselves caused by severe stresses in the real economy. What matters, then, is the feedback loops between real shocks and credit.

Figure 2.7.Asia: Credit to Private Sector during Previous Recessions since 1980

(Median, year-on-year percent change, peak of the recessions =0)

Source: IMF staff estimates.

The lesson for the current cycle is clear: Asia should strive to preserve the stability of its domestic financial systems. While the region has suffered from the global reappraisal of risk in the form of capital outflows, declines in equity prices, and tight domestic liquidity conditions among other symptoms, core systems have remained stable and have been able to reintermediate credit in the face of limited external funding. With corporates and households in the region coming under stress, banks themselves will likely suffer. As explained in Chapter 3, declines in capital asset ratios are expected to be manageable, yet vigilance is needed in the face of history’s lessons: banking stress could make the current recession, already of historical proportions owing to the size of the external shock, even longer and deeper.

Do Some Economies Suffer Deeper Recessions?

Different economies in Asia seem to suffer comparable recessions on average. Decomposing Asian economies in different subgroups—regional groupings, commodity importers versus exporters, high export exposure versus low export exposure, etc.—does not signal major differences in median duration or output loss of recessions across groups (Figure 2.8). Commodity exporters—Australia, New Zealand, Indonesia, Malaysia—seem to suffer deeper losses, but this is because two of the three recessions in Indonesia and Malaysia were banking crises.

Figure 2.8.Asia by Regional Groups: Cumulative Output Loss during Previous Recessions since 1980

(Median, in percent)

Source: IMF staff estimates.

However, of relevance to the current context, export-dependent economies are doubly vulnerable to export shocks because their domestic demand seems less autonomous from the export cycle.12 Not only did GDP fall by more in these countries during export recessions, but consumption and investment fell as well (Figure 2.9). Given the limited number of export-led recessions, we estimated the dynamic impact of export shocks on consumption and investment growth in the two sets of economies over the entire sample, by means of a panel vector autoregression (VAR).13 The results confirm that export shocks have substantially larger effects in the high export exposure group. In terms of magnitude, a 15 percentage point decline in year-on-year growth of real exports—a decline of similar magnitude to that experienced in Asia in recent months—leads in the estimated model to a 6 percentage point decline in real investment growth in high export exposure countries, versus a 2 percentage point decline in low export exposure economies (Figure 2.10). Moreover, the impact in the former group is persistent, with investment growth returning to preshock levels only a year and a half after the shock. The impact on consumption growth is smaller in magnitude but still not trivial: in trade-dependent economies, consumption growth declines by about 1½ percentage points following the shock.

Figure 2.9.Asia by Type of Export Activity: Real Gross Domestic Product during 2000–01 Recession1

(Median level, peak of the recession =100)

Source: IMF staff estimates.

1 Includes countries that were not in recession in 2000–01, excluding China and India.

Figure 2.10.Asia: Response of Real Gross Fixed Investment Growth to a Shock to Real Export Growth1

(In percentage points)

Source: IMF staff estimates.

1 A shock of 15 percentage points is considered here.

Thus, past recession patterns yield two meaningful insights: banking sector stress greatly amplifies recessions, and export-dependent economies are more vulnerable in the face of external demand shocks. What lessons can we learn from the pattern of past recoveries? This is the purpose of our next section.

Past Recoveries: How Vigorous?

Patterns of recovery in Asia are relatively more homogeneous than those of recessions, and tend to be characterized by a strong rebound in exports and a relatively weak contribution from domestic demand. More specifically:

  • Many recoveries in Asia have been “investment-less.” In the typical recovery, investment remains flat post-trough for about three quarters, and then picks up the pace very gradually (Figure 2.11). Moreover, only 4 out of the 33 recoveries in the sample were led by a recovery in investment, defined as an upturn in investment post-trough that preceded the upturn in consumption and exports. Why has investment been so sluggish to recover? Excess pre-recession capacity may be part of the answer. Numerous studies have pinned excess investment before the Asian financial crisis as one reason investment appeared to be so weak after the crisis.14 In fact, the collapse of investment in Asia following the 1997–98 crisis has often been cited as one of the root causes of the current account imbalances that have dominated the global economy in the past decade. Yet this crisis was not the only one during which investment failed to recover strongly. For instance, the recovery after the 2000–01 recession was even weaker, with investment stuck at trough levels for a full three years.15 Once again, excess capacity before the crisis, in this case concentrated in the information technology (IT) sector, led to weak investment after the crisis. It is an open and important question why investment in Asia appears to follow such pronounced boom and bust cycles.

  • Consumption played an important role in a limited number of recoveries. Consumption recoveries led about 9 of the 33 GDP recoveries in the sample. Surprisingly, consumption led the recovery in several of the Asian-crisis episodes, for example in Korea and Singapore, and to a lesser extent in Thailand (Figure 2.12). This is in contrast with received wisdom that countries exited the Asian crisis thanks to sharp depreciations and export rebounds. This being said, it is doubtful that these consumption recoveries would have been sustainable had exports not recovered sharply soon after.

  • Exports, then, have been the main engine of recoveries in Asia. In the recovery phase, exports tend to rebound strongly, with export volumes typically more than 10 percent higher than their trough levels four quarters on (Figure 2.13). Not only was the rebound in exports key to the recovery in many export recessions, but growth in exports also led GDP and the other demand components in 16 out of the other 25 recoveries (i.e., recoveries following nonexport recessions).16 Export rebounds appear to have been helped by currency depreciations, a common feature of Asian recessions, with stronger export recoveries associated with larger real effective depreciations in our sample (Figure 2.14). Finally, of relevance to the current context, most export rebounds in our sample happened in periods of better-than-acceptable growth in the G-2. A clear case is the post-2001 rebound in Asian exports, which coincided with the recovery in the United States and Europe from their own recessions. In other words, Asia never exited a recession through exports in our sample at a time of weak growth in the G-2.

Figure 2.11.Asia: Real Gross Fixed Investment during Previous Recessions since1980

(Median level, trough of the recessions =100)

Source: IMF staff estimates.

Figure 2.12.Selected Asia: Real Private Consumption Expenditure during the Asian Crisis

(Trough of the recession =100)

Source: IMF staff estimates.

Figure 2.13.Asia: Real Exports of Goods and Services during Previous Recessions since 1980

(Median level, trough of the recessions =100)

Source: IMF staff estimates.

Figure 2.14.Asia: Real Effective Exchange Rate during Previous Recessions since1980

(Median, peak of the recessions =100)

Source: IMF staff estimates.

Given the importance of export growth in the recovery phase, this presents the question of whether export-dependent economies experience sharper recoveries. The answer is yes, both because the recovery in exports is sharper—perhaps owing to a higher elasticity of exports to foreign demand in these countries—and because the recovery in exports translates into a stronger recovery in domestic demand (Figure 2.15). Median GDP levels are 5 percentage points higher one year after the trough in high export exposure economies, and the difference cannot be explained by higher trend growth in this group.

Figure 2.15.Asia: Previous Recessions since 1980 by Type of Export Intensity of the Economies

(Median real level, trough of the recessions = 100)
(Median real level, trough of the recessions = 100)
(Median real level, trough of the recessions = 100)

Source: IMF staff estimates.

Because recoveries in Asia have typically relied on a single engine, they have tended to be weaker than in other regions. It typically takes emerging Asia three quarters to recover its recession output loss, when other emerging markets take two quarters to recover an output loss that was on average greater. Put differently, growth in the recovery phase in Asia is typically ½ percentage point lower per quarter (nonannualized) than in other emerging economies (Figure 2.16). A key difference is that non-Asia emerging economies typically benefit from a strong V-shaped recovery in investment.

Figure 2.16.Average Quarterly Growth during Recovery

(In percent, nonannualized)

Source: IMF staff estimates.

Finally, are deeper recessions followed by sharper recoveries? The answer is a clear no. If output was trend stationary, a deeper recession could be followed by a sharper recovery. But the key is that deep recessions appear to entail permanent rather than just cyclical losses, violating the assumption of trend stationarity. In the deepest recession episodes, quarterly (annualized) potential output growth falls by some 1½ percentage points, compared with about ⅓percentage point in the median recession (Figure 2.17). The cumulative impact of such a decline is significant: a 1 percentage point decline in annualized quarterly trend growth means that GDP would be 10 percent lower after 10 years.

Figure 2.17.Asia: Change in Trend GDP Growth during Previous Recessions since 19801

(In percent)

Source: IMF staff estimates.

1 Difference in average annualized quarterly growth between eight quarters before peak and eight quarters after trough of the recessions.

Policy Responses and Impacts

As Asia grapples with the question of the right size and composition of the policy response in the current recession, it may be useful to put current policies in the context of past responses. In particular, how large and timely have these responses typically been, and to what extent did they limit the impact of recessions and speed up recoveries?

Asia has taken advantage of countercyclical tools in past recessions. Despite a large literature documenting the procyclicality of fiscal and monetary policies in emerging economies,17 our event study analysis shows that monetary and fiscal policies in Asia tend to loosen in response to recessions. Looking at monetary policy, interest rates have typically been reduced by 50 basis points (bps) over the full year after the recession (Figure 2.18). Needless to say, this was simply the median response: some recessions were met with higher policy rates to defend exchange rate pegs (as during the Asian crisis), whereas others were met with very aggressive policy loosening. Declines in nominal rates were enough to outpace falling inflation, as witnessed by the fact that median real interest rates fell as well. And, as mentioned earlier, exchange rate depreciations have been a common feature of recessions in Asia.

Figure 2.18.Asia: Nominal Policy Rates during Previous Recessions since 1980

(Median, in percent, peak of the recessions =0)

Source: IMF staff estimates.

Although monetary policy is often thought of as the first line of defense, fiscal policy has also played its part in Asia. In past recessions, fiscal balances have typically been more than 1½ percent of GDP lower a year after the peak. This was in part due to falling revenues in the recession, but expenditures also tended to be raised—by 1 percent of GDP over one year (Figure 2.19).18 Equally noteworthy, the response of fiscal policy has typically been quite timely, with expenditures ½ percent of GDP higher one quarter after the recession started.

Figure 2.19.Asia: Fiscal Indicators during Previous Recessions since 1980

(Median, in percent of GDP, peak of the recessions =0)

Source: IMF staff estimates.

Has countercyclical monetary and fiscal policy been effective? Reverse causality hampers a proper answer to this question, because stronger policy responses tend to be observed during deeper recessions. To circumvent this problem, we constructed a counterfactual scenario. Specifically, we borrowed from the academic literature standard values for the dynamic impact of monetary and fiscal policy on GDP, and used these multipliers together with the actual policy changes during recessions to compute how much lower GDP would have been had policy not been loosened.19 The results show that, in the absence of observed policy changes, GDP would have been somewhat lower and the recovery shallower and more delayed. Because policy impacts operate with lags, the gap between the actual and counterfactual paths does not become substantial until one year after the start of the recession, but after two years the GDP counterfactual is 3 percentage points lower than actual GDP (Figure 2.20).

Figure 2.20.Asia: Impact of Policy Actions during Previous Recessions since 1980

(Median real GDP, peak of the recessions =100)

Source: IMF, WEO database.

The policy response in the current recession has been substantially stronger than that during past recessions. The median decline in policy rates across all countries in the region exceeds 200 basis points (bps) since the third quarter of last year, four times more than the median response in past recessions. Similarly, the median expected change in overall fiscal balances during 2009 is over 3½ percent of GDP, more than double the response following the Asian crisis (Figure 2.21).20 Although these numbers underscore the severity of the current recession, they also highlight the benefits of conservative policies followed in the past decade, which expanded the available monetary and fiscal space when the crisis hit the region.

Figure 2.21.Asia: Change in Fiscal Balance in Selected Recessions

(Median, in percent of GDP)

Source: IMF, WEO database.

Concluding Remarks

Minimizing the depth and duration of the current recession means essentially two things for Asia: preserving the stability of core banking systems, and putting less emphasis on an export recovery. History suggests that cracks in the banking sector could worsen an already painful recession. Although financial systems in Asia remain well capitalized and capable of intermediating credit, persistent stress in the corporate sector and associated job losses mean that pressure on banks is likely to intensify. Authorities should thus remain vigilant and stand ready to stabilize banking sector conditions if needed. And just as the region’s reliance on exports is a key reason it has suffered greatly in this recession, the Asian model of relying on exports to lead the recovery may not be as successful as in the past, given the weak expected recovery in the G-2. In this sense, it is reassuring that countercyclical policies are being deployed to a greater extent than in past recessions. At the same time, households in advanced economies will need to repair their over-leveraged balance sheets over time, and the era of easy credit to finance purchases of consumer durables could well be over. In such an environment, the structural growth rate of Asian manufacturing and exports could be much lower. Structural reforms, such as expansion of social safety nets and deepening of domestic financial markets, will be needed if Asia wants to diversify its sources of growth more durably.

Appendix 2.1

Table 2A.1.Asia: Identification of Previous Recessions since 1980
Recession episodesRecessions identified with
Financial

stress
Domesitc

banking crisis
Export

demand shock
Japan1992Q2-1992Q3
1997Q2-1999Q1
2001Q2-2001Q4
Australia1981Q4-1983Q2
1990Q2-1991Q3
New Zealand1982Q4-1983Q1
1985Q2-1986Q1
1989Q3-1990Q2
1991Q1-1991Q2
1997Q4-1998Q1
Hong Kong SAR1982Q1-1982Q2
1989Q1-1989Q2
1995Q2-1995Q3
1997Q4-1998Q4
2001Q1-2001Q4
2003Q1-2003Q2
Korea1979Q3-1980Q2
1997Q4-1998Q2
Singapore1985Q2-1985Q4
1997Q4-1998Q3
2001Q1-2001Q3
2002Q3-2003Q2
Taiwan2000Q4-2001Q3
Province of China2003Q1-2003Q2
Indonesia1998Q1-1998Q4
Malaysia1998Q1-1998Q3
2001Q1-2001Q2
Philippines1983Q3-1985Q3
1990Q4-1991Q2
1992Q1-1992Q2
1998Q1-1998Q2
2000Q4-2001Q1
Thailand1996Q4-1998Q3
Sources: Laeven and Valencia (2008); Lall, Cardarelli and Elekdag (2008); and IMF staff estimates.
Sources: Laeven and Valencia (2008); Lall, Cardarelli and Elekdag (2008); and IMF staff estimates.

Data Coverage

The sample of Asia and Pacific economies includes Japan, Australia, New Zealand, China, India, Hong Kong SAR, Korea, Taiwan Province of China, Indonesia, Malaysia, the Philippines, and Thailand, although no recessions were identified in China or India.

The sample of advanced economies includes Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom, and the United States.

The sample of non-Asian emerging economies includes Argentina, Brazil, Chile, Colombia, Costa Rica, Croatia, Ecuador, Islamic Republic of Iran, Latvia, Lithuania, Mexico, Peru, Poland, Russia, South Africa, Serbia, the Slovak Republic, Turkey, Uruguay, and Venezuela (other economies were part of the sample but no recession was identified for them).

The data are quarterly, and we focus on the post-1980 period because of the dramatic changes in the structure of Asian economies over the past four decades.

The Bry-Boschan Algorithm

Recessions are identified using the Bry-Boschan (1971) algorithm. Formally, the algorithm follows:

yt is defined as local peak if ytyt-1> 0, ytyt-2>0,

yt+1yt <0, and yt+2yt <0;

yt is defined as local trough if ytyt-1< 0, ytyt-2< 0,

yt+1yt > 0 and yt+2yt >0,

where t denotes a given quarter.

A recession is defined as the time (i.e., number of quarters) between the local peak and local trough. The cumulative output loss in the recession is the cumulative difference across all recession quarters between actual GDP and the level of GDP at the local peak.

A recovery is defined as the time between the local trough and the first quarter in which GDP equals or exceeds GDP at the previous peak. An expansion defines the time between a local trough and the next local peak.

Finally, note that official business cycle dates are available for a few countries only. Even when available, the study used the Bry-Boschan algorithm to date the cycles in order to preserve a common methodology across countries.

Financial Stress Recessions

A recession is defined as a financial stress recession if:

  • an advanced economies Financial Conditions Index (FCI) is at least one standard deviation above its mean (indicating greater-than-average stress) in any of the four quarters before of the recession, and/or

  • the country was experiencing a systemic banking crisis during the recession, as defined by Laeven and Valencia (2008).

The advanced economies FCI is drawn from Cardarelli, Elekdag, and Lall (forthcoming), and is an equal-variance weighted average of seven variables: stock market declines, time-varying stock price and real exchange rate volatility, corporate spread, TED spread, inverted term spread, and the banking sector β (i.e., covariance between financial stocks and the overall market). See Cardarelli, Elkdag, and Lall (forthcoming) for more details.

Ideally, financial stress recessions in the chapter would have been identified with an Asia FCI analogous to the advanced economies FCI, rather than relying on a composite of two different, not directly comparable variables. Unfortunately, data limitations mean that an Asia FCI could only be computed for the post-1996 period, making it unsuitable for this chapter.

Vector Autoregressions (VARs)

The VARs are run in panel form, and include four variables: the year-on-year (y/y) growth of private domestic demand in the United States, and the y/y growth of private consumption, investment, and exports in country i, where i belongs to the panel of countries. We allow for country-specific fixed effects but otherwise impose common coefficients across countries in the panel. Eight lags are imposed, and the impulse responses presented in the text of this chapter are the generalized impulses normalized so that the export growth shock equals 15 percentage points on impact. We run the VARs for two panels of Asian economies: (1) Hong Kong SAR, Korea, Singapore, Taiwan Province of China, Malaysia, and Thailand (high export exposure group); and (2) Japan, Australia, New Zealand, India, and the Philippines (low export exposure group). Indonesia was excluded from the second group because the panel VAR did not display well-defined impulse responses when including Indonesia.

Constructing the Counterfactual

We constructed an artificial counterfactual GDP by subtracting from actual output the impact of monetary and fiscal policy changes observed during recessions (we looked at the policy actions that took place over four quarters starting at peak). The assumed impact on GDP per 100 bps reduction in the policy rate was derived from the IMF’s Global Economic Model and amounts to 0.48 percentage points for Japan, 0.44 for Australia and New Zealand, 0.60 for Korea and Taiwan Province of China; and 1.40 for ASEAN-4 countries, Hong Kong SAR, and Singapore. The impact of monetary policy was assumed to be staggered across four quarters. The impact of fiscal policy on quarterly GDP was assumed to be 0.7 for each percentage point change in the expenditure to GDP ratio. Because these multipliers derive from calibrated models (as opposed to being estimated) they are not subject to the reverse causality problems.

Note: The main authors of this chapter are Souvik Gupta and Jacques Miniane.

While some papers such as Kim, Kose, and Plummer (2003) have looked at business cycle dynamics in Asia, there are fewer studies looking specifically at recession and recovery episodes in the region. One of these is Hong, Lee, and Tang (2009), who use annual rather than quarterly data as is done in this chapter. The use of annual data allows the authors to cover a longer data span, but at the cost of a less precise identification of business cycle turning points and hence the dynamics of different components around these key dates.

See Appendix 2.1 for details on the Bry-Boschan algorithm.

See Appendix 2.1 for details on the construction of the global Financial Conditions Index, as well as the banking crisis indicator.

We exclude the current recession precisely because it is still ongoing and hence of unknown depth and duration. Note that Vietnam was excluded from the sample because its quarterly GDP series is too short and appears too smooth.

See Guimarães-Filho and others (2008) for discussion on Asia’s deepening integration with the global economy.

See Aguiar and Gopinath (2007) among others.

Given Asia’s higher trend growth precrisis, however, it is not clear that recessions in Asia have been less costly if measured not in terms of output loss relative to peak but in terms of the output gap. We did not use the output gap as measure of the cost of recessions because of the difficulty in properly estimating potential output during a recession.

This result thus confirms for Asia what had been previously found for advanced economies in Cardarelli, Elekdag, and Lall (forthcoming) and Reinhart and Rogoff (2009).

Highly export dependent economies are the newly industrialized economies (NIEs) and Malaysia, and low export dependence economies are Australia, Indonesia, Japan, New Zealand, the Philippines, and Thailand. This classification uses data on Asian countries’ direct and indirect export exposure to the United States and the euro area presented in Guimarães-Filho and others (2008).

See Appendix 2.1 for details on the VAR.

See IMF (2006) among others.

In some economies like Hong Kong SAR, this could be due to the “SARS” recession coming quickly after the IT recession. Moreover, apparent weakness in the investment recovery post 2001 may have been exaggerated by the surge of regional FDI flows toward China in this period.

To summarize, 60 percent of recoveries were led by exports, 30 percent by consumption, and 10 percent by investment.

See Kaminsky and others (2004), among others.

We do not have enough data to determine how much of this jump is due to discretionary spending and how much to automatic stabilizers, but the latter tend to be small in Asia.

See Appendix 2.1 for details on the construction of the counterfactual scenario.

The number for 1998 is limited to standard fiscal outlays and excludes bank recapitalization costs.

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