Hong Kong's Currency Crisis: A Test of the 1990s ‘Washington Consensus’ View

• Date: 01 December 2014
• Author: Wissam Harake,Ellen E. Meade
• Published date: 01 December 2014
• DOI: http://doi.org/10.1111/infi.12053

Hong Kong’s Currency Crisis:

A Test of the 1990s ‘Washington

Consensus’View

Wissam Harake

y

and Ellen E. Meade

z

y

The World Bank, and

z

Division of Monetary Affairs, Federal Reserve

Board of Governors

Abstract

In the aftermath of the financial crisis that rocked Southeast Asia in

1997–98, prominent sc holars argued tha t the advice disp ensed by the

Internationa l Monetary Fund and s upported by the policy communit y

in Washington had exacerbated rather than stabilized the crisis. In this

paper, we look back at that debate by using Hong Kong’s experience

during the Asian financial cris is to test the then‐co nsensus view on

monetary tightening against the revisionist view of its critics. Hong

Kong provides an in teresting test o f the two approaches because mone-

tary policy was tightened and the pre‐crisis exchange rate survived the

speculative attack intact, in contrast to other studies that have examined

the effects of tighter monetary policy during attacks that led to changes

in exchange‐rate management. Usin g a model of exchange ‐market pres-

sure and VAR estimation, we find that our results are generally support-

ive of the revisionist hypothesis.

The authors would like to thank two anonymous referees for comments. The views

expressed in this paper are those of the authors and do not reflect the official views of the

World Bank or the Federal Reser ve Board.

International Finance 17:3, 2014: pp. 273–296

DOI: 10.1111/infi.12053

Published 2014. This article is a U.S. Government work and is in the public domain in the USA.

I. Introduction

In the immediate aftermath of the financial crisis that rocked Southeast Asia

in 1997–98, a number of prominent scholars (see Furman and Stiglitz 1998;

Radelet and Sachs 1998) argued that the advice dispensed by the Interna-

tional Monetary Fund (IMF) and supported by the policy community in

Washington –then known as the ‘Washington Consensus’–had exacerbated

rather than stabilized the crisis. According to the p revailing view i n the

international policy community at the time, the appropriate policy response

to a speculative attack on an exchange‐rate peg was a significant increase in

domestic interest rates designed to stabilize the demand for the currency and

deter further speculation. The critics called for expansionary monetary

policy similar to the countercyclical policies later adopted in advanced

economies during the 2007–08 financial crisis. Instead of boosting confi-

dence and ending the speculative attacks against exchange‐rate pegs in Asia,

these revisionists argued that the traditional policies associated with the IMF

led instead to a further loss of confidence, expectations of widespread

bankruptcies and bank failures, and resulted in additional pressure on

exchange rates.

1

The ‘Washington Consensus’agenda has a long history. When John

Williamson first employed the term in 1989, he was referring to a set of

policy instruments that ha d broad support in the intern ational policy com-

munity and had been standard comp onents of policy program mes in Latin

America during the 1980s ( Williamson 1990). But in the 1990s, the t erm

became identified with a neoliberal po licy agenda and market fundamental-

ism (for a discussion of the tran sformation of Williamson’s orig inal agenda,

see Williamson 2008; Fischer 2012). Naím (200 0, p. 88) notes that, ‘The term

Washington Consensus soon acquired a life of its own, becomin g a brand

name known worldwide and used independ ently of its original intent and

even of its content’. The neoliberal agenda promoted a small public sector,

deregulation, privatizat ion, free trade and the dismantl ing of restrictions on

capital flows. For countries tr ying to balance macroeconom ic objectives for

growth and employment with the maintenance of an exchange‐rate peg, the

freeing up of capital flows subjected th em to a trilemma or impossib le trinity

of policy objectives (see Obst feld et al. 2005). At that time, ‘the id ea that the

unimpeded flow of capital around the glob e, like the free flow of goods and

1

Furman and Stiglit z (1998) and Radelet and Sa chs (1998) are part of t he third‐generation

currency crisis literature, which emphasizes the role of balance sheet effects following

exchange‐rate devalua tions; Burnside et al. (2008) and Glick an d Hutchinson (2013) pr ovide

an overview of th ird‐generation models.

274 Wissam Harake and Ellen E. Meade

Published 2014. This article is a U.S. Government work and is in the public domain in the USA.