Dealing with bank system failure: Indonesia, 1997-2003

Abstract

Indonesia's crisis recovery program has failed badly in relation to the two key objectives of development economics policy making: efficiency and equity. The economy went into severe recession within a few months of the IMF appearing on the scene, and six years later output was little higher than before the crisis. The collapse of the banking system and the associated government bailout of depositors has imposed a loss on the public of at least 40% of GDP. This paper describes that collapse and the government's policy response to it, under advice from the IMF. It goes on to propose an alternative scheme that might have been followed-and that could be followed in future banking crises. Its twin objectives are to maintain the integrity of the payments system and to avoid inequitable wealth transfers that result from government bailouts of banks and their depositors.