The Indonesian Financial Crisis Essay Online For Freedere

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The occurrence and severity of the Indonesian financial crisis in 1997 surprised everyone. Indonesian economic performance has ranked among the best in the world, so that praised by the World Bank (1993) as a part of East Asian miracle. Hill (1998) notes that before the crisis “almost every technical economic indicator looked safe”. Economic growth was robust in average of 7.9 percent during 1990 to 1996. The inflation rate associated with the growth path was persistently high, but was still below 10 percent. The average inflation rate associated with the 7.9 percent was 8.3 percent in CPI, and even reached 6.5 percent in 1996. As pointed out by McLeod (1997), inflation was falling, not rising, and the relatively large current account deficit was not caused by unsustainably rapid growth but by high capital inflow, which made sustainable high growth possible, and was itself a response to high returns to investment in Indonesia. In other words, the deficit on current account of the balance of payments looked manageable. The fiscal accounts were in surplus, except a little negative in 1992 and 1993. The structure of savings and investment associated with the growth path was good enough. Official foreign exchange reserves looked adequate and were trending upwards. Even many also believed that Indonesia was in much better position and strategy in responding to the regional currency crisis compared to Thailand. (Feridhanusetyawan, et al, 1998). First, macroeconomic indicators, especially current account deficit was at around 4 percent of GDP while Thailand already reached around 9 percent. Second, Indonesia’s Rupiah was not fixed like the Thai Bath, which allowed for some adjustments in responding to the speculative attacks. Third, the slowdown in export growth in 1996 was not as severe as Thailand mainly because real wages grew at much slower rate due to less tight labor market compared to Thailand. In short time after the crisis started, however, it was clear that Indonesia was in much worse condition compared to other Asian countries in crisis. Both foreign and domestic investors have fled, and hundreds of corporations are bankrupt. The banking system has effectively ground to a halt, with very little new lending taking place and dozens of banks insolvent. Domestic demand has plummeted. Thousands of Indonesians have lost their jobs, and millions more face a substantial reduction in their standard of living. (Radelet, 1999) Even after ten years of Indonesian crisis, it is still unclear what really the roots of crisis. The common agreement among scholars is that the existing models so called first generation models (Krugman, 1979; Flood and Garber, 1984) and second generation models (Obstfeld, 1986) failed to explain the Indonesian financial crisis. The failure of the first generation models can be seen from these facts. Government budget was balance or moving into surplus (partly in appropriate fiscal response to higher net private capital flows). Growth in monetary aggregates was fairly high, but cannot be described as runaway monetary expansion. Inflation rate was coming down, nominal GDP growth was largely at levels corresponding to money creation,

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