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Old and Modern Currency Crises: Short-Term Liabilities, Speculative Attacks and Business Cycles

  • Mariassunta Giannetti

Today?s level of financial integration and development of international capital markets is often compared to the pre-World War I Gold Standard. However, the propensity to currency crises seems higher today than in the past. Furthermore, the dynamics of crises has changed: In the most recent episodes of currency crises, output contractions have been large, but they have been followed by prompter recoveries than in the past. This paper shows that high volatility in the demand for domestic currency, due to international investors buying short-term liquid assets, may increase the probability of currency crises and lead to large contractions followed by fast recoveries. Due to the "speculative" demand for currency, a small productivity shock can prompt a drop in the demand for domestic currency and the consequent exhaustion of international reserves. Therefore, crises can happen also when the fundamentals are relatively good: Investment drops temporarily due to the devaluation and recovers fast afterwards. In contrast, if the economy has smaller short-term liabilities, like during the pre-World War I Gold Standard, currency crises happen only when the real sector of the economy experiences a strong negative productivity shock. If productivity shocks have some degree of persistence, there are prolonged recessions.

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 133.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:133
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