Business cycle accounting East and West: Asian finance and the investment wedge

While a large literature studies the causes of financial crises, little is known about the mechanisms by which crises lead to output drops. We perform an exploratory analysis of output drops by applying the Business Cycle Accounting (BCA) methodology developed by Chari et al. (2007) to a sample of 23 crises. The BCA procedure estimates the wedges, and thus the kinds of distortions, that are most relevant in explaining output movements in each episode. Our results make a case for separating East Asian crises, which are mostly driven by the efficiency and investment wedges, from crises elsewhere, which are mostly driven by the efficiency and labor wedges. These findings are consistent and complementary with studies of Asian financial systems, which highlight the influence of Japanese institutions and practices, including relationship-based as opposed to market-based lending, and reluctance to impose bankruptcy.

► Business cycle accounting for 23 financial crises.
► Efficiency wedge most important, followed by labor and investment wedges.
► Crises in East Asia deeper and more investment-driven.
► Results remarkably consistent with Cargill and Parker (2002) theory of Asian financial systems.
► Results robust to variable capital utilization.