The first measure to tackle economic contraction and rising unemployment in the short term is definitely the policies to stimulate domestic demand. On the other hand, in the famous Asian and Russian crises emerged in the second half of 1990s as well as in the following crisis in Turkey, countries where the crises emerged or spread to implemented a remedy in the opposite direction: they tightened monetary and fiscal policies.

Why? The rationale behind this was:  "If the economy had significant vulnerabilities, these pushes up the risk perception about those certain countries. So, real interest rates and exchange rates in those countries increase while financial asset prices decrease. Sectors that have foreign exchange denominated debts (corporate and financial sectors) and sectors that hold financial assets widely (predominantly the financial sector) get affected negatively. Risk perception increases further. Developing vulnerabilities pushes up interest rates and exchange rates, and reduces financial asset prices further. Under these circumstances, supply of and demand for credits in those countries diminish; operating capitals evaporate and firms face difficulties in fulfilling obligations before banks. As a result, consumption and investments tighten. Unemployment rate rises while the economy shrinks. In that case, it is of necessity to advance upon the vulnerabilities and reduce risk perception.  For instance, if the major vulnerability stems from high public debt with short maturity and high cost (interest), this situation must be reversed. And this can be achieved through fiscal discipline."

This was the main rationale behind the fiscal and monetary contraction adopted by countries with high vulnerability after the crisis in order to ensure economic growth. A typical example for this was the economic program implemented in Turkey following the 2001 crisis. In the 2002-2006 period, considerable budget discipline and monetary discipline were secured. Nevertheless, Turkey's economy grew by more than 7 percent. There is no doubt that abundant global liquidity also had a part in this achievement. But if Turkey did not take important steps to tidy up the economy, this could not be achieved.

In the early 2000s, important developments arose in emerging market economies. In most of them, public debt decreased continuously to quite low levels. Budget deficits stopped to be a problem. Financial sectors recovered. Those countries secured themselves in front of the risk of rapid capital flights; they improved their foreign exchange reserves.

Some typical examples: The picture when the LA7 group, the seven largest economies of Latin America; i.e. Argentina, Brazil, Columbia, Mexico, Peru, Chile and Venezuela, is taken as a whole: Ratio of public debt to national income rose to the highest value with 60 percent in 2002. After that year, it decreased continuously and reached 34 percent in 2008. Over the same period, ratio of foreign exchange reserves to national income increased from 2 to 8 percent. Same things can also be observed in Turkey.

When emerging market economies are considered as a whole, however, it is observed that right before the global crisis (at the end of 2007), risk in these countries were at historically lowest level. Therefore, as a response to the contracting and unemployment increasing impacts of the global crisis, these countries would have been expected to give up the old policies. And they did so. Most emerging market economies increased public expenditures significantly and at the same time cut interest rates and taxes. Of course these countries were faced with different conditions at the end of 2007; and the measures taken represented those differences. For instance, for developing countries in G-20 and Czech Republic, Hungary and Poland are analyzed together; it is possible to conclude that: considering the end of 2007, lowest the ratio of public debt, budget deficit and current account deficit to national income were, strongest were the response these counties gave to stimulate domestic demand in the midst of the crisis.

However, when their responses were compared with the responses by developed countries, a significant difference in favor of the latter appears. What is more, most of the macroeconomic indicators I listed above are less favorable in developed countries. To put it differently, if economic conditions in emerging market economies was replaced with the conditions in some developed at the end of 2007, emerging market economies would have never temp to give the same response. Where does this difference stem from? I will continue tomorrow.

This commentary was published in Radikal daily on 04.10.2009