Working Paper: CEPR ID: DP2170
Authors: Olivier Jeanne
Abstract: This paper puts recent theoretical developments in the literature on currency crises in perspective by comparing two theoretical approaches, one based on the speculative attack model of Krugman-Flood-Garber and the other approach, which evolved following the 1992-93 crisis of the European Monetary System, and that we call here "escape clause". The escape clause approach broadens the set of fundamentals to nonmonetary variables, including unemployment or the state of the banking sector, and even "softer" fundamentals such as the reputation of the policymaker and the rules of the game played by the participants in a fixed exchange rate arrangement. It also suggests that the relationship between the economic fundamentals and devaluation expectations is in general nonlinear, and may give rise to multiple equilibria. We argue that, while the speculative attack approach provides useful insights on the anatomy of currency crises, it must be complemented by the escape clause approach if one wants to understand the underlying causes of the crises that we have witnessed in the 1990s.
Keywords: currency crises; european monetary system; self-fulfilling speculation; speculative attack; multiple equilibria; contagion; escape clause; fixed exchange rate systems; fundamentals
JEL Codes: F30; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| poor policymaking (D78) | currency crises (F31) |
| deteriorating economic conditions (E66) | speculative attacks (D84) |
| market expectations (D84) | economic fundamentals (E25) |
| currency crises (F31) | market behaviors (D43) |
| market participants' perception of escape clause (E44) | currency crises (F31) |