Working Paper: NBER ID: w7211
Authors: Allan Drazen
Abstract: Existing models of contagious currency crises are summarized and surveyed, and it is argued that more weight should be put on political factors. Towards this end, the concept of political contagion introduced, whereby contagion in speculative attacks across currencies arises solely because of political objectives of countries. A specific model of membership' contagion is presented. The desire to be part of a political-economic union, where maintaining a fixed exchange rate is a condition for membership and where the value of membership depends positively on who else is a member, is shown to give rise to potential contagion. We then present evidence suggesting that political contagion may have been important in the 1992-3 EMS crisis.
Keywords: currency crises; political contagion; speculative attacks
JEL Codes: F30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| political objectives (L21) | speculative attacks on currencies (F31) |
| devaluation of one currency (F31) | likelihood of speculative attacks on another currency (F31) |
| political integration objectives (F55) | decision-making process of governments (D72) |
| decision-making process of governments (D70) | market expectations and speculative behavior (D84) |