url
15
Aug
2014

ASIAN CURRENCY CRISIS: A Benchmark Model

Section 5 shows that in our simple model, the optimal policy is to abandon fixed exchange rates as soon as information about higher prospective deficits arrives. Since this result reflects, in part, the absence of nominal rigidities in our model, it serves primarily to highlight the costs of delaying a speculative attack. In reality, these costs must be counterbalanced against the benefits (if any) of delay.

Section 6 offers empirical evidence in support of the three key assumptions in our model: (i) foreign reserves do not play a special role in the timing of the attack; (ii) large losses in the banking sector are associated with increases in governments’ prospective deficits; and (iii) the public knows that banks are in trouble before the exchange rate crisis occurs. To address (i), we examine the behavior of foreign exchange reserves prior to the crises.

To address (ii) we use information on pre and post currency crisis loan default rates to generate rough estimates of governments’ total implicit liabilities to the financial sector. To address (iii) we construct and analyze stock market based measures of the value of financial and nonfinancial sectors in the crisis countries. We find strong evidence that in Korea, Thailand, and to a lesser extent Malaysia and the Philippines, the value of the financial sector had been declining, in both absolute and relative terms, well before their currency crises. Coupled with the institutional information summarized by Corsetti, Pesenti and Roubini (1998), this constitutes strong evidence in favor of assumption (iii). Finally, Section 7 presents concluding remarks and discusses some shortcomings of our analysis.

A Benchmark Model

In this Section we describe a continuous time, perfect foresight endowment economy populated by an infinitely lived representative agent and a government. All agents, including the government, have access to international capital markets.
The government faces a standard present value budget constraint and finances expenditures through lump sum taxes, seignorage revenues and borrowing.
There is a single consumption good in the economy and no barriers to trade, so that purchasing power parity holds: payday loans online direct lenders

w6758-1
Here bt and dt denote real domestic government debt and net foreign assets held by the representative agent, respectively, у denotes the constant exogenous endowment of output, v denotes the constant level of lump sum transfers from the government, r denotes the constant level of lump sum taxes, and irt is the inflation rate. The variable mt represents real money balances, defined as mt = Mt/Pt, where Mt denotes nominal money holdings. Throughout the paper xt denotes ‘jjf.

Constraint (2.3) takes into account the possibility of discrete changes in mt, dt, and bt at a finite set of points in time.

Section 5 shows that in our simple model, the optimal policy is to abandon fixed exchange rates as soon as information about higher prospective deficits arrives. Since this result reflects, in part, the absence of nominal rigidities in our model, it serves primarily to highlight the costs of delaying a speculative attack. In reality, these costs must be counterbalanced against the benefits (if any) of delay. Section 6 offers empirical evidence in support of the three key assumptions in our model: (i) foreign reserves do not play a special role in the timing of the attack; (ii) large losses in the banking sector are associated with increases in governments’ prospective deficits; and (iii) the public knows that banks are in

About The Author

Kevin J. Brandon

Home | Site Map | Contacts

Copyright © 2013 - 2019 Investment And Finance Online. All rights reserved