Rational expectations
Rational expectations
The crucial role of timely, credible and comprehensive
information in the financial market has been reemphasized in the
wake of the latest bout of speculative attacks on the currencies
of several countries in Southeast Asia. The most notable attacks
being on Thailand, the Philippines, Malaysia and Indonesia.
That the financial industry, notably the foreign exchange
market, is highly sensitive to information is nevertheless not a
new phenomenon. But this fact, established a long time ago
through a series of empirical studies, resurfaced after an ASEAN
reaction to the regional currency instability..
The foreign ministers of the nine-member Association of
Southeast Asian Nations (ASEAN) agreed, at their latest annual
meeting in Kuala Lumpur late last month, to blame an
international conspiracy for the speculative assaults on their
currencies.
The ministers, riled by the currency speculations despite what
they persistently claim as their strong economic fundamentals,
agreed in their joint statement that the speculative attacks
could be traced to well coordinated efforts to destabilize ASEAN
currencies for self-serving purposes. Prime Minister Mahathir
Mohamad of Malaysia, the host of the meeting, even went as far as
singling out American financier George Soros.
However understandable the foreign ministers' disillusion with
the havoc caused by the currency crisis-- because the economic
fundamentals of their countries (except Thailand) have been
assessed even by international analysts as fairly sound-- finding
a scapegoat is not useful, if not a wholly futile exercise.
American Undersecretary of State for Economic Affairs Stuart
E. Eizenstat, who visited Jakarta last week after the Kuala
Lumpur meeting, conveyed a more sensible message. He asserted at
a news conference that it had been the strained economy of a
country (in this case Thailand) which set off its currency
instability with a consequent contagion to other Southeast Asian
countries.
Eizenstat said the regional currency volatility had not been
triggered by speculators. In fact, it was because the financial
markets detected problems and reacted accordingly. Speculators
only took advantage of this trend and made money. But as its name
suggests, speculation usually spreads quickly and widely on the
back of irrational expectations. However speculation lasts only
for a short period of time until a sensible reality once again
prevails.
What Eizenstat implicitly alluded to is that market perception
of an economy's condition greatly influences the price of its
currency. The market perception in turn influences the rational
market expectations of appreciation or depreciation of a
particular currency. Herein lies the pivotal role of timely,
credible, comprehensive information on an economy. It is this
information which affects market perception.
This, however, does not defy the fact that sound economic
fundamentals and prudent macro-economic management as well as a
consistent policy are prerequisites for maintaining a stable
currency. However they are, by themselves, not enough.
Lack of credible, timely information could create a wide gap
between how the condition of an economy is perceived by the
market and the actual situation.
As the financial market -- of which the foreign exchange
market is the largest segment with an estimated average daily
turnover of more than US$1.3 trillion -- has increasingly been
globalized, it has also become more sensitive to information.
It is no wonder, therefore, that the International Monetary
Fund has issued guidelines for countries regarding the kind of
basic or key economic indicators they should disseminate to the
market. The more up-to-date, comprehensive and credible the
disseminated information, the more effective it will be in
preventing or reducing the gap between the market perception and
the actual condition of an economy.
Well-informed markets have rational expectations and minimize
the possibilities of irrational, wild speculations.