Currency Crises: A Challenge to Economic Theory and Economic Policy
AbstractFrom the viewpoint of policy makers, the understanding of the causes and the course of financial crises remains inadequate. The theoretical analysis of currency crises has been hampered by the lack of empirical regularities in those of the past. Nonetheless, attempts are made repeatedly to provide a canonical explanation of international financial crises and to propose economic policies to prevent such crises. This article surveys the recent theoretical, empirical and economic policy literature on financial crises (with emphasis on the Asian crisis). Much of the recent theoretical literature, in particular that dealing with the Asian crisis, refers to the complex relationship between the constitutive imperfections of financial markets resulting from asymmetric information and the worldwide liberalization of the financial and capital markets. It is an outstanding feature of financial markets that they are strongly dominated by expectations. The actual market outcome may correspond to expectations even if these expectations were unjustified ex ante or absurd. Thus, expectations determine whether market outcomes tend toward a "good" or "bad" equilibrium. In principle, changes in international investors" expectations for the worse – whether justified or not – may trigger crises (self-fulfilling crises) and move a country from a "good" (high growth) to a "bad" (low growth) equilibrium. According to the views of leading theoreticians and practitioners, this mechanism was the preeminent element of the Asian crisis. It is a surprising insight that "self-fulfilling crises" may indeed be the result of rational behavior, given the constitutive imperfections of financial and capital markets. In a world of liberalized financial markets, such crises cannot in principle be averted and are very difficult to forecast. A reversal of the liberalization of financial markets or the re-introduction of capital controls would be the wrong response, however. A superior option in economic policy is the establishment of "support" systems to increase the efficiency and stability of international financial markets. Core elements of such systems would be institutions of financial surveillance and monitoring, which among other tasks could fulfill the important function of a "lender of last resort" at the international level, and provide an internationally accepted set of rules for standstill agreements, debt relief for and financial default of countries.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by WIFO in its journal WIFO-Monatsberichte.
Volume (Year): 71 (1998)
Issue (Month): 9 (September)
Postal: Austrian Institute of Economic Research Publikationsverkauf und Abonnentenbetreuung Arsenal, Objekt 20 A-1030 Vienna/Austria
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Azariadis, Costas & Guesnerie, Roger, 1986. "Sunspots and Cycles," Review of Economic Studies, Wiley Blackwell, vol. 53(5), pages 725-37, October.
- Diamond, Douglas W, 1997.
"Liquidity, Banks, and Markets,"
Journal of Political Economy,
University of Chicago Press, vol. 105(5), pages 928-56, October.
- Demirguc-Kent, Asli & Detragiache, Enrica, 1998.
"Financial liberalization and financial fragility,"
Policy Research Working Paper Series
1917, The World Bank.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ilse Schulz).
If references are entirely missing, you can add them using this form.