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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
Date of revision:
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
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  7. Obstfeld, Maurice, 1996. "Models of Currency Crises with Self-fulfilling Features," CEPR Discussion Papers 1315, C.E.P.R. Discussion Papers.
  8. 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.
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  10. 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.
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  14. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1998. "Prospective deficits and the Asian currency crisis," Working Paper Series WP-98-5, Federal Reserve Bank of Chicago.
  15. van Wijnbergen, Sweder, 1991. "Fiscal Deficits, Exchange Rate Crises and Inflation," Review of Economic Studies, Wiley Blackwell, vol. 58(1), pages 81-92, January.
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  18. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
  19. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  20. Rebelo, Sergio & Xie, Danyang, 1999. "On the optimality of interest rate smoothing," Journal of Monetary Economics, Elsevier, vol. 43(2), pages 263-282, April.
  21. Guillermo A. Calvo & Carlos A. Vegh, 1999. "Inflation Stabilization and BOP Crises in Developing Countries," NBER Working Papers 6925, National Bureau of Economic Research, Inc.
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  24. Calvo, Guillermo A, 1987. "Balance of Payments Crises in a Cash-in-Advance Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(1), pages 19-32, February.
  25. Feenstra, Robert C, 1985. "Anticipated Devaluations, Currency Flight, and Direct Trade Controls in a Monetary Economy," American Economic Review, American Economic Association, vol. 75(3), pages 386-401, June.
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