url
11
Aug
2014

ASIAN CURRENCY CRISIS: Introduction

Recent events in Southeast Asia have renewed interest in the causes and consequences of speculative attacks on fixed exchange rate regimes. The explanation preferred by policy makers in Southeast Asia is that the currency crisis was a self fulfilling prophecy: it happened because speculators thought it was going to happen.1 Not surprisingly, proponents of this view argue that the International Monetary Fund should provide resources to fend off such predatory attacks and help prey countries recover from them. Multiple equilibrium models of currency crises can be used to rationalize this interpretation of recent events in Southeast Asia.

The most natural alternative explanation of the Southeast Asian currency crisis is that it reflected profligate fiscal policy: ongoing fiscal deficits led to sustained reserve losses and to the eventual abandonment of fixed exchange rates. This is the standard view of speculative attacks in ‘first generation’ models of currency crises. To articulate this view, the speculative attacks literature focuses on two types of policy experiments: (i) an increase in the fiscal deficit that must eventually be monetized; and (ii) an exchange rate peg that is unsustainable because it reduces the government’s seignorage revenues without compensating fiscal adjustments. Both experiments imply that the collapse of a fixed exchange rate is preceded by ongoing deficits and rising debt levels. This has motivated a large body of empirical work aimed at predicting currency crises on the basis of fiscal deficits and other macroeconomic aggregates.

The standard explanation for speculative attacks has an obvious shortcoming when applied to Southeast Asia: governments of the crisis countries (Indonesia, Korea, Malaysia, the Philippines, and Thailand) were running either surpluses or small deficits and had substantial foreign exchange reserves. Indeed, when they abandoned fixed exchange rates, all had more than enough reserves to buy back the monetary base, and virtually all of Ml (see Section 6).

This evidence notwithstanding, we argue that the Southeast Asian currency crises were caused by fundamentals: large prospective deficits associated with implicit bailout guarantees to failing banking systems. The expectation that these future deficits would (at least in part) be financed by seignorage revenues led to a collapse of the fixed exchange rate regimes in Southeast Asia. Of course market participants could have believed that governments would fund their obligations by raising taxes or lower expenditures. But is this credible? In our view it is not. The state of the world in which financial intermediaries would suffer grievous losses is exactly the state of the world in which current and prospective real output and tax revenues would fall. payday loan direct lenders

Recent events in Southeast Asia have renewed interest in the causes and consequences of speculative attacks on fixed exchange rate regimes. The explanation preferred by policy makers in Southeast Asia is that the currency crisis was a self fulfilling prophecy: it happened because speculators thought it was going to happen.1 Not surprisingly, proponents of this view argue that the International Monetary Fund should provide resources to fend off such predatory attacks and help prey countries recover from them. Multiple equilibrium models of currency crises can be used to rationalize this interpretation of recent events in Southeast Asia. The most natural alternative explanation of the Southeast Asian currency crisis is that it reflected profligate fiscal policy: ongoing fiscal deficits led to

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Kevin J. Brandon

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