1. The canonical model
2. More sophisticated models
3. Disputed issues: self-fulfilling crises, herd behavior, large agents, contagion
4. Case study 1: the ERM crises of 1992-3
5. Case study 2: the Latin crisis, 1994-5
6. Case study 3: the Asian crisis, 1997-?
7. Macroeconomic questions
8. Can crises be prevented?
On July 2 of this year, after months of asserting thatit would do no such thing, the government of Thailand abandoned its efforts to maintain a fixed exchange rate for the baht. The currency quickly depreciated by more than 20 percent; within a few days most neighboring countries had been forced to emulate the Thai example.
What forced Thailand to devalue its currency was massive speculation against the baht, speculation that over a few months hadconsumed most of what initially seemed an awesomely large warchest of foreign exchange. And why were speculators betting against Thailand? Because they expected the baht to be devalued, of course.
This sort of circular logic - in which investors flee a currency because they expect it to be devalued, and much (though usually not all) of the pressure on the currency comes precisely because of thisinvestor lack of confidence - is the defining feature of a currency crisis. We need not seek a more formal or careful definition; almost always we know a currency crisis when we see one. And we have been seeing a lot of them lately. The 1990s have, in fact, offered the spectacle of three distinct regional waves of currency crises: Europe in 1992-3, Latin America in 1994-5, and the Asian crisesstill unfolding at the time of writing.
Currency crises have been the subject of an extensive economic literature, both theoretical and empirical. Yet there remain some important unresolved issues, and each new set of crises presents new puzzles. The purpose of this paper is to provide an overview both of what we know and of what we do not know about currency crises, illustrated by reference torecent experience.
The paper begins by describing the "canonical" crisis model, a simple yet suggestive analysis that was developed 20 years ago but remains the starting point for most discussion. Despite that canonical model's virtues, however, it has come in for justified criticism because of its failure to offer a realistic picture either of the objectives of central banks or of the constraintsthey face; thus the paper turns next to a description of "second-generation" crisis models that try to remedy these defects.
As it turns out, second-generation models have suggested a reconsideration of a basic question that the canonical model seemed to have answered: are currency crises always justified? That is, do currencies always get attacked because the markets perceive (rightly orwrongly) some underlying inconsistency in the nation's policies, or can they happen arbitrarily to countries whose currencies would otherwise have remained sound? The paper describes several different scenarios for currency crises that are not driven by fundamentals, including self-fulfilling crises in which endogenous policy ends up justifying investor pessimism, "herding" by investors, and themachinations of large agents ("Soroi"). Closely related to the question of arbitrary crises is "contagion", the phenomenon in which a currency crisis in one country often seems to trigger crises in other countries which which it seemingly has only weak economic links (e.g., Mexico and Argentina, or Thailand and the Philippines).
From there the paper moves to cases, considering in turn the three regionalcrisis waves of the 90s (so far).Comparison of these waves turns out to raise a further puzzle: while the onset of crisis was similar in each case, the consequences of the crises seem to have been very different in the European as opposed to the Latin and Asian cases.
Finally, of course, we must ask the big question: is there any way to make crises less frequent, and if so what?