High Growth and Low Consumption in East Asia: How to Improve Welfare While Avoiding Financial Failures
IMF Working Papers, December 1, 2007
Source details
- Canonical URL
- High Growth and Low Consumption in East Asia: How to Improve Welfare While Avoiding Financial Failures
Other formats
Bibliographic details
- Authors: Celine Rochon, Andrew Feltenstein, Maral Shamloo
- Published: December 1, 2007
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451868418.001
Summary / Abstract
- The paper analyzes policies typical of a number of rapidly growing East Asian countries in which a fixed exchange rate, combined with a surplus labor market, has made domestic assets relatively inexpensive.
- Resulting dynamics generate high rates of FDI as well as domestic capital formation, producing an "investment hunger" that can lead to unanticipated declines in the returns to investment and resulting financial insolvencies.
- Private consumption remains low and there are concerns that high savings rates cannot be sustained.
- The authors construct a dynamic general equilibrium model and apply it to a stylized Asian economy, loosely based upon China.
- The paper calibrates a benchmark equilibrium and carries out counterfactual simulations to analyze alternative policies, in particular tax cuts and exchange rate revaluations, as instruments to increase private consumption while avoiding bank failures.
Model, Calibration, and Counterfactual Simulations
- Model: dynamic general equilibrium model tailored to a stylized Asian economy.
- Calibration: benchmark equilibrium calibrated to the stylized economy (loosely based upon China).
- Counterfactual simulations: used to evaluate alternative policies, with emphasis on:
- tax cuts; and
- exchange rate revaluations.
Key Findings and Mechanisms
- Fixed exchange rate plus surplus labor market => domestic assets relatively inexpensive.
- Low relative price of domestic assets => high rates of FDI and domestic capital formation ("investment hunger").
- Investment hunger can produce unanticipated declines in the returns to investment.
- Declines in returns to investment can lead to financial insolvencies and bank failures.
- Private consumption remains low despite high growth and high savings rates; sustainability of high savings rates is a concern.
Policy Instruments and Implications
- Evaluated instruments:
- tax cuts (as a tool to increase private consumption); and
- exchange rate revaluations (as a tool to increase private consumption).
- Objective: increase private consumption while avoiding bank failures.
- Policy trade-offs: interventions must balance boosting consumption against risks to financial stability stemming from investment returns and bank solvency.
Subject Areas and Keywords
- Subject: Banking, Consumption, Exchange rates, Foreign direct investment, Real interest rates
- Keywords: exchange rate, interest rate, rate of return, WP