The effects of inequality in the 1997-98 Asian crisis and the 2008-09 global tsunami: The case of five Asian economies

Abstract This paper discusses why the Asian banking sector was so vulnerable to financial crisis in 1997-98 but so resilient to global turmoil in 2008-09. While current account imbalances and short-term capital flows are widely perceived to be responsible for banking crises, rising income inequality is found in our study to exert an indirect yet ultimate impact on financial instability. The change or level of inequality may affect an economy’s growth strategy, which has a fundamental implication for external vulnerability and crisis risk. We also show that economic growth is financially less risky if led by export with stable trade surpluses than by overinvestment funded with volatile capital flows. Our results are derived from economic modeling based on uncovered interest parity and confirmed by empirical evidence found from Asian data.