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Prospective Deficits and the Asian Currency Crisis

  • Craig Burnside
  • Martin Eichenbaum
  • Sergio Rebelo

This paper argues that the recent Southeast Asian currency crisis was caused by large prospective deficits associated with implicit bailout guarantees to failing banking systems. We articulate this view using a simple dynamic general equilibrium model whose key feature is that a speculative attack is inevitable once the present value of future government deficits rises. This is true regardless of the government's foreign reserve position or the initial level of its debt. While the government cannot prevent a speculative attack, it can affect its timing. The longer the delay, the higher inflation will be under flexible exchange rates. We present empirical evidence in support of the three key assumptions in our model: (i) foreign reserves did not play a special role in the timing of the attack, (ii) large losses in the banking sector were associated with large increases in governments' prospective deficits, and (iii) the public knew that banks were in trouble before the currency crisis.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6758.

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Date of creation: Oct 1998
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Publication status: published as Burnside, Craig, Martin Eichenbaum and Sergio Rebelo. "Prospective Deficits And The Asian Currency Crisis," Journal of Political Economy, 2001, v109(6,Dec), 1155-1197.
Handle: RePEc:nbr:nberwo:6758
Note: EFG IFM
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  2. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "Paper tigers? A model of the Asian crisis," Research Paper 9822, Federal Reserve Bank of New York.
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  7. Burstein, Ariel T. & Neves, Joao C. & Rebelo, Sergio, 2003. "Distribution costs and real exchange rate dynamics during exchange-rate-based stabilizations," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1189-1214, September.
  8. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "What caused the Asian currency and financial crisis?," Japan and the World Economy, Elsevier, vol. 11(3), pages 305-373, October.
  9. Maurice Obstfeld & Kenneth Rogoff, 1995. "The mirage of fixed exchange rates," Working Papers in Applied Economic Theory 95-08, Federal Reserve Bank of San Francisco.
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  18. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  19. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March.
  20. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
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  24. Koenig, Evan F, 1987. "The Short-run 'Tobin Effect' in a Monetary Optimizing Model," Economic Inquiry, Western Economic Association International, vol. 25(1), pages 43-53, January.
  25. Dupor, Bill, 2000. "Exchange rates and the fiscal theory of the price level," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 613-630, June.
  26. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
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