Currency crisis

models of currency crises.[3]

A currency crisis is when, serious doubt exists as to

whether a countrys central bank has sucient foreign exchange reserves to maintain the countrys xed exchange
rate. The crisis is often accompanied by a speculative
attack in the foreign exchange market. A currency crisis results from chronic balance of payments decits, and
thus is also called a balance of payments crisis. Often
such a crisis culminates in a devaluation of the currency.

1.1 First generation

The 'rst generation' of models of currency crises began
with Paul Krugman's adaptation of Stephen Salant and
Dale Hendersons model of speculative attacks in the gold
market.[4] In his article,[5] Krugman argues that a sudden
speculative attack on a xed exchange rate, even though
it appears to be an irrational change in expectations, can
result from rational behavior by investors. This happens
if investors foresee that a government is running an excessive decit, causing it to run short of liquid assets or
harder foreign currency which it can sell to support its
currency at the xed rate. Investors are willing to continue holding the currency as long as they expect the exchange rate to remain xed, but they ee the currency en
masse when they anticipate that the peg is about to end.

A currency crisis is a type of nancial crisis, and is often

associated with a real economic crisis. Currency crises
can be especially destructive to small open economies or
bigger, but not suciently stable ones. Governments often take on the role of fending o such attacks by satisfying the excess demand for a given currency using the
countrys own currency reserves or its foreign reserves
(usually in the United States dollar, Euro or Pound sterling). Currency crises have large, measurable costs on an
economy, but the ability to predict the timing and magnitude of crises is limited by theoretical understanding of
the complex interactions between macroeconomic fundamentals, investor expectations, and government policy.[1]

1.2 Second generation

There is no widely accepted denition of a currency crisis, which is normally considered as part of a nancial crisis. Kaminsky et al. (1998), for instance, dene currency
crises as when a weighted average of monthly percentage
depreciations in the exchange rate and monthly percentage declines in exchange reserves exceeds its mean by
more than three standard deviations. Frankel and Rose
(1996) dene a currency crisis as a nominal depreciation
of a currency of at least 25% but it is also dened at least
10% increase in the rate of depreciation. In general, a
currency crisis can be dened as a situation when the participants in an exchange market come to recognize that a
pegged exchange rate is about to fail, causing speculation
against the peg that hastens the failure and forces a devaluation or appreciation, see Al-Assaf et al. (2013).[2]

The 'second generation' of models of currency crises

starts with the paper of Obstfeld (1986).[6] In these models, doubts about whether the government is willing to
maintain its exchange rate peg lead to multiple equilibria,
suggesting that self-fullling prophecies may be possible,
in which the reason investors attack the currency is that
they expect other investors to attack the currency.

1.3 Third generation

'Third generation' models of currency crises have explored how problems in the banking and nancial system
interact with currency crises, and how crises can have real
eects on the rest of the economy.[7]

Recessions attributed to currency crises include the 1994

economic crisis in Mexico, 1997 Asian Financial Crisis,
McKinnon & Pill (1996), Krugman (1998), Corsetti, Pe1998 Russian nancial crisis, and the Argentine economic
senti, & Roubini (1998) suggested that over borrowing
crisis (1999-2002).
by banks to fund moral hazard lending was a form of
hidden government debts (to the extent that governments
would bail out failing banks).

Theories

Radelet & Sachs (1998) suggested that self-fullling panics that hit the nancial intermediaries, force liquidation
The currency crises and sovereign debt crises that have of long run assets, which then conrms the panics.
occurred with increasing frequency since the Latin Amer- Chang and Velasco (2000) argue that a currency crisis
ican debt crisis of the 1980s have inspired a huge amount may cause a banking crisis if local banks have debts deof research. There have been several 'generations of nominated in foreign currency,[8]
1

Burnside, Eichenbaum, and Rebelo (2001 and 2004) argue that a government guarantee of the banking system
may give banks an incentive to take on foreign debt, making both the currency and the banking system vulnerable
to attack.[9][10]
[11]

Krugman(1999)
suggested another two factors, in an
attempt to explain the Asian nancial crisis: (1) rms
balance sheets aect their ability to spend, and (2) capital ows aect the real exchange rate. (He proposed his
model as yet another candidate for third generation crisis modeling (p32)). However, the banking system plays
no role in his model. His model led to the policy prescription: impose a curfew on capital ight which was
implemented by Malaysia during the Asian nancial crisis.

EXTERNAL LINKS

Currency
Currency transaction tax
Economic collapse
Exorbitant privilege
Financial market
Financial transaction tax
Fluctuation in exchange rates
Foreign exchange controls
Foreign exchange market

Eurozone crisis as a balance-ofpayments crisis

According to some economists the ongoing Eurozone crisis is in fact a balance-of-payments crisis or at least can
be thought of as at least as much as a scal crisis.[12] According to this view, a capital ow bonanza of private
funds took place during the boom years preceding this
crisis into countries of Southern Europe or of the periphery of the Eurozone, including Spain, Ireland and Greece;
this massive ow nanced huge excesses of spending over
income, i.e. bubbles, in the private sector, the public sector, or both. Then following the global nancial crisis of
200708, came a sudden stop to these capital inows that
in some cases even led to a total reversal, i.e. a capital
ight.[13]

Global Justice Movement

Jubilee 2000
Liquidity crisis
Money market
Paul Bernd Spahn
Spahn tax
Speculation
Speculative attack

Sudden stop (economics)

Others, like some of the followers of the Modern Monetary Theory (MMT) school, have argued that a region
Speculation in foreign exchange markets
with its own currency cannot have a Balance of Payments
crisis because there exists a mechanism, the TARGET2
Tobin tax
system, that ensures that Eurozone member countries can
always fund their current account decits.[14][15] These
authors do not claim that the current account imbalances 3.1 Related economic crises
in the Eurozone are irrelevant but simply that a currency
union cannot have a balance of payments crisis proper.[16]
1994 economic crisis in Mexico
Some authors tackling the crisis from an MMT perspective have claimed that those authors who are denoting the
1997 Asian Financial Crisis
crisis as a 'balance of payments crisis are changing the
meaning of the term.[15][17]
1998 Russian nancial crisis

See also

Argentine economic crisis (19992002)

Financial crisis of 20072010

Alter-globalization
ATTAC (Association for the Taxation of Financial
Transactions for the Aid of Citizens)
Central banks - which issue currency

4 External links
Mindmapping for Economic Crises

References

[1] Federal Reserve Bank of San Francisco, Currency Crises,

September 2011
[2] Al-Assaf, G., Al-Tarawneh, A., Alawin, M., (2013), DETERMINANTS OF CURRENCY CRISIS IN JORDAN
A MULTINOMIAL LOGIT MODEL, European Scientic Journal, Vol. 9. No. 34. http://eujournal.org/index.
php/esj/article/view/2178
[3] Craig Burnside, Martin Eichenbaum, and Sergio Rebelo
(2008), 'Currency crisis models', New Palgrave Dictionary
of Economics, 2nd ed.
[4] Salant, Stephen; Henderson, Dale (1978). Market
anticipations of government policies and the price of
gold. Journal of Political Economy 86: 62748.
doi:10.1086/260702.
[5] Krugman, Paul (1979). "'A model of balance-ofpayments crises". Journal of Money, Credit, and Banking
11: 31125. doi:10.2307/1991793.
[6] Obstfeld, Maurice (1986). "'Rational and self-fullling
balance-of-payments crises". American Economic Review 76 (1): 7281.
[7] Chang, R.; Velasco, A. (2001).
"'A model of
currency crises in emerging markets".
Quarterly Journal of Economics 116 (2):
489517.
doi:10.1162/00335530151144087.
[8] Chang, R.; Velasco, A. (2000). "'Financial fragility and
the exchange rate regime'". Journal of Economic Theory
92: 134. doi:10.1006/jeth.1999.2621.
[9] Burnside, C.; Eichenbaum, M.; Rebelo, S. (2001).
"'Hedging and nancial fragility in xed exchange rate
regimes". European Economic Review 45: 115193.
doi:10.1016/s0014-2921(01)00090-3.
[10] Burnside, C.; Eichenbaum, M.; Rebelo, S. (2004).
"'Government guarantees and self-fullling speculative
attacks". Journal of Economic Theory 119: 3163.
doi:10.1016/j.jet.2003.06.002.
[11] Balance Sheets, the Transfer Problem, and Financial
Crises. International Finance and Financial Crises: Essays in Honor of Robert P. Flood, Jr. Bosten: Kluwer
Academic, 31-44.
[12] Selected sources on viewing the Eurozone Crisis as a
balance-of-payments crisis:
Krugman, Paul (September 23, 2011). Origins of
the Euro Crisis. The New York Times.
Krugman, Paul (November 7, 2011). Wishful
Thinking And The Road To Eurogeddon. The
New York Times.
Krugman, Paul (February 25, 2012). European
Crisis Realities. The New York Times.
Krugman, Paul (September 14, 2013). But
Wheres My Phoenix?". The New York Times.

Krugman, Paul (August 26, 2014). Currency

Regimes, Capital Flows, and Crises. IMF Economic Review (Palgrave Macmillan) 62: 470493.
doi:10.1057/imfer.2014.9.
Wolf, Martin (April 10, 2012). Why the Bundesbank is wrong. Financial Times.
Davies, Gavyn (November 6, 2011). The eurozone
decouples from the world. Financial Times.
Verma, Sid (November 8, 2011). The eurozone
crisis as balance of payment problem. Financial
Times Alphaville.
Avent, Ryan (November 28, 2011). Who killed
the euro zone?". The Economist.
Nixon, Simon (December 2, 2012). Euros Unity
Continues to Defy the Bears. The Wall Street Journal.
Sinn, Hans Werner (October 3, 2011). How to rescue the euro: Ten commandments. Vox.
Pisani-Ferry, Jean; Merler, Silvia (April 2, 2012).
Sudden stops in the Eurozone. Vox.
Alessandrini, Pietro; Hallett, Andrew Hughes;
Presbitero, Andrea F; Fratianni, Michele (May 16,
2012). The Eurozone crisis: Fiscal fragility, external imbalances, or both?". Vox.
Mansori, Kash (September 22, 2011). What Really Caused the Eurozone Crisis? Part 1. The
Street Light.
Mansori, Kash (September 27, 2011). What Really Caused the Eurozone Crisis? Part 2. The
Street Light.
Mayer, Thomas (October 26, 2011). Bttcher,
Barbara, ed. EU Monitor 88: Eurolands hidden
balance-of-payments crisis (PDF). Deutsche Bank
Research.
CESifo Forum Special Issue January 2012.
CESifo Group Munich. 2012.
[13] Pisani-Ferry, Jean; Merler, Silvia (April 2, 2012).
Sudden stops in the Eurozone. Vox. Accominotti,
Olivier; Eichengreen, Barry (September 14, 2013). The
mother of all sudden stops: Capital ows and reversals in
Europe, 1919-1932. Vox.
[14] Wray, Randall (July 16, 2012). MMT AND THE
EURO: Are Current Account Imbalances to Blame for the
Euro Disaster? Part 2. Economonitor.
[15] Pilkington, Philip (September 2, 2013). Playing Humpty
Dumpty: More on the Denition of Balance of Payments
Crisis"". Fixing the Economists.
[16] Wray, Randall (July 12, 2012). MMT AND THE
EURO: Are Current Account Imbalances to Blame for the
Euro Disaster? Part 1. Economonitor.
[17] Pilkington, Philip (August 31, 2013). Can a country
without a currency have a currency crisis?". Fixing the
Economists.

6 TEXT AND IMAGE SOURCES, CONTRIBUTORS, AND LICENSES

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