The East Asian Model and the Currency Crisis: Credit Policy and Mundell–Fleming Flows

We attempt a story that accounts for both the East Asian crisis and the East Asian success that preceded it. A two‐sector growth model of a small semi‐open economy is proposed, which reflects most of the features of the so‐called East Asian model: a pegged exchange rate, a regulated capital account and a developmental state wielding tight monetary and credit policy (including credit rationing) to allocate resources towards maximizing export growth and capital accumulation. This means capital starvation for most of the non‐tradable sector. Singular success and the end of the Cold War induced political and economic liberalizations in the 1990s which raised real wages and threatened growth. The deregulation of Mundell–Fleming flows appearing as the least politically costly response to changing comparative advantage induced easy money and endogenized credit allocation which promptly financed asset price imbalances in favour of non‐tradables. The latter dictated the allocation of borrowed resources that made the financial crisis inevitable. We argue that the currency crisis presents East Asia with an opportunity à la Olson upheaval to return to its roots, a path that Taiwan has taken and one which the US Treasury and the International Monetary Fund will have none of.