Currency crises: theoretical and empirical overview of the 1990s

Currency crises: theoretical and empirical overview of the 1990s

The private sectors, national governments and international financial institutions must co-operate to avoid future crises

This paper provides an overview of currency crises theories, methods for crises prediction, implications of currency crises for economic policy, as well as different currency crises episodes in the 1990s, namely the Asian, Russian and Brazilian financial crises.

The theoretical models of currency crises can be divided into three generations of models:

  • first-generation models, first found in the work o f P.Krugman in the 1970s, characterised by movements of fundamental macroeconomic variables incompatible with the proclaimed level of exchange rate, especially in fixed exchange rate regimes, which leads to a speculative attack
  • second-generation models, which begin with the work of M.Obstfeld, stress the expectations of economic subjects and of markets, which can, without major changes in government policy or in the movements of fundamental macroeconomic variables, leads to speculative attacks
  • third-generation models, based on the experience of the Asian crisis, point to the fact that there are real causes of crisis which, because of state guarantees and a poor banking system, spill over to the financial system and hence the exchange rate too

Findings of the paper include the following:

  • a crisis can be forestalled if it is detected in its early stage and appropriate measures are undertaken; however this poses a great challenge that requires better co-operation between private investors and economic policy makers
  • since the exchange rate regime is a crucial element in precipitating a crisis, it is important to take into account changes in the regime
  • the Asian, Russian and Brazilian crises have confirmed once again that the international financial system needs to be adjusted in order to decrease the possibility of a crisis and to reduce its extent. The private sectors, national governments and international financial institutions,such as the IMF, play the major role in this process

[adapted from authors]