Working Paper: CEPR ID: DP2015
Authors: Craig Burnside; Martin Eichenbaum; Sergio Rebelo
Abstract: This paper argues that the recent Southeast Asian currency crises was caused by large prospective deficits associated with implicit bailout guarantees to failing banking systems. We articulate this view using a simple dynamic general equilibrium model whose key feature is that a speculative attack is inevitable once the present value of future government deficits rises. This is true regardless of the government's foreign reserve position or the initial level of its debt. While the government cannot prevent a speculative attack, it can affect its timing. The longer the delay, the higher inflation will be under flexible exchange rates. In our model we present empirical evidence in support of the three key assumptions: (i) that foreign reserves did not play a special role in the timing of the attack; (ii) that large losses in the banking sector were associated with large increases in governments' prospective deficits; and (iii) that the public knew that banks were in trouble before the currency rate crises.
Keywords: currency crisis; banking crisis; speculative attacks; asia
JEL Codes: F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large prospective deficits (H68) | speculative attack (D84) |
| information about increased future deficits (H68) | inevitability of a speculative attack (D84) |
| government actions (management of seignorage revenues) (E63) | timing of speculative attack (D84) |
| public's knowledge of banking sector troubles (G21) | timing of speculative attack (D84) |
| substantial losses in banking sector (F65) | increases in prospective government deficits (H68) |
| foreign reserves (F31) | timing of speculative attack (D84) |