Currency crisis

Source: Wikipedia, the free encyclopedia.
(Redirected from
Balance of payments crisis
)

A

fixed exchange rate
, if it has any.

The crisis is often accompanied by a

GDP growth and high levels of foreign exchange reserves.[3] To offset the damage resulting from a banking or default crisis, a central bank will often increase currency issuance, which can decrease reserves to a point where a fixed exchange rate breaks. The linkage between currency, banking, and default crises increases the chance of twin crises or even triple crises, outcomes in which the economic cost of each individual crisis is enlarged.[4]

Currency crises can be especially destructive to small

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.[5] A currency crisis may also have political implications for those in power. Following a currency crisis a change in the head of government and a change in the finance minister and/or central bank governor are more likely to occur.[6]

A currency crisis is normally considered as part of a financial crisis. Kaminsky et al. (1998), for instance, define 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) define a currency crisis as a nominal depreciation of a currency of at least 25% but it is also defined at least 10% increase in the rate of depreciation. In general, a currency crisis can be defined 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.[citation needed]

Recessions attributed to currency crises include the

Turkey
currency crises and their corresponding socioeconomic collapse.

Theories

The currency crises and sovereign debt crises that have occurred with increasing frequency since the Latin American debt crisis of the 1980s have inspired a huge amount of research. There have been several 'generations' of models of currency crises.[7]

First generation

The 'first generation' of models of currency crises began with Paul Krugman's adaptation of Stephen Salant and Dale Henderson's model of speculative attacks in the gold market.[8] In his article,[9] Krugman argues that a sudden speculative attack on a fixed 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 deficit, causing it to run short of liquid assets or "harder" foreign currency which it can sell to support its currency at the fixed rate. Investors are willing to continue holding the currency as long as they expect the exchange rate to remain fixed, but they flee the currency en masse when they anticipate that the peg is about to end.

Second generation

The 'second generation' of models of currency crises starts with the paper of Obstfeld (1986).[10] In these models, doubts about whether the government is willing to maintain its exchange rate peg lead to multiple equilibria, suggesting that self-fulfilling prophecies may be possible. Specifically, investors expect a contingent commitment by the government and if things get bad enough, the peg is not maintained. For example, in the 1992 ERM crisis, the UK was experiencing an economic downturn just as Germany was booming due to the reunification. As a result, the German Bundesbank increased interest rates to slow the expansion. To maintain the peg to Germany, it would have been necessary for the Bank of England to slow the UK economy further by increasing its interest rates as well. As the UK was already in a downturn, increasing interest rates would have increased unemployment further and investors anticipated that the UK politicians were not willing to maintain the peg. As a result, investors attacked the currency and the UK left the peg.

Third generation

'Third generation' models of currency crises have explored how problems in the banking and financial system interact with currency crises, and how crises can have real effects on the rest of the economy.[11] McKinnon & Pill (1996), Krugman (1998), Corsetti, Pesenti, & Roubini (1998) suggested that "over borrowing" by banks to fund moral hazard lending was a form of hidden government debts (to the extent that governments would bail out failing banks).[citation needed] Radelet & Sachs (1998) suggested that self-fulfilling panics that hit the financial intermediaries, force liquidation of long run assets, which then "confirms" the panics.[citation needed]

Chang and Velasco (2000) argue that a currency crisis may cause a banking crisis if local banks have debts denominated in foreign currency,[12] 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.[13][14]

Krugman (1999)

Asian financial crisis: (1) firms' balance sheets affect their ability to spend, and (2) capital flows affect 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 flight which was implemented by Malaysia during the Asian financial crisis.[citation needed
]

Eurozone crisis as a balance-of-payments crisis

European 10 year bonds, before the Great Recession in Europe bonds floated together in parity
  Greece 10 year bond
  Portugal 10 year bond
  Ireland 10 year bond
  Spain 10 year bond
  Italy 10 year bond
  France 10 year bond
  Germany 10 year bond
Ireland bond prices, Inverted yield curve in 2011[16]
  15 year bond
  10 year bond
  5 year bond
  3 year bond

According to some economists the

financial crisis of 2007–08, came a sudden stop to these capital inflows that in some cases even led to a total reversal, i.e. a capital flight.[18]

Others, like some of the followers of the

Modern Monetary Theory (MMT) school, have argued that a region with its own currency cannot have a balance-of-payments crisis because there exists a mechanism, the TARGET2 system, that ensures that Eurozone member countries can always fund their current account deficits.[19][20] These authors do not claim that the current account imbalances in the Eurozone are irrelevant but simply that a currency union cannot have a balance of payments crisis proper.[21] Some authors tackling the crisis from an MMT perspective have claimed that those authors who are denoting the crisis as a 'balance of payments crisis' are changing the meaning of the term.[20][22]

See also

Related economic crises

References

  1. S2CID 5960798
    .
  2. doi:10.1093/wber/16.2.151
    .
  3. S2CID 237827555
    .
  4. ISBN 9781429278430
    .
  5. ^ Federal Reserve Bank of San Francisco, Currency Crises, September 2011
  6. S2CID 154951242
    .
  7. ^ Craig Burnside, Martin Eichenbaum, and Sergio Rebelo (2008), 'Currency crisis models', New Palgrave Dictionary of Economics, 2nd ed.
  8. S2CID 677477
    .
  9. JSTOR 1991793
    .
  10. JSTOR 1804128
    .
  11. doi:10.1162/00335530151144087
    .
  12. hdl:10419/100855
    .
  13. doi:10.1016/s0014-2921(01)00090-3
    .
  14. doi:10.1016/j.jet.2003.06.002
    .
  15. ^ 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.
  16. S2CID 225624817
    . Retrieved 5 April 2023.
  17. ^ Selected sources on viewing the Eurozone Crisis as a balance-of-payments crisis:
  18. ^ 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 flows and reversals in Europe, 1919-1932". Vox.
  19. Economonitor
    .
  20. ^
    Pilkington, Philip (September 2, 2013). "Playing Humpty Dumpty: More on the Definition of "Balance of Payments Crisis""
    . Fixing the Economists.
  21. Economonitor
    .
  22. Pilkington, Philip (August 31, 2013). "Can a country without a currency have a currency crisis?"
    . Fixing the Economists.
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