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A Simple Model Of Currency Crises And Budget Deficits: The Case Of Turkey

  • Ongan, Tevfik Hakan
  • Karabulut, Gökhan
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    The aim of this paper is to explore the determinants of currency crises and to illustrate the dynamic behaviour of the fundamental macroeconomic variables in a small open economy under a peg regime. The mainstream models in currency crises literature are not sufficiently available to explain the recent Turkish currency crisis observed in 2000. Turkey was successful to fix domestic credit at the same time with a crawling peg regime in order to achieve price stability. Furthermore, the political preferences were also in favour of continuing the program. Though these facts, the peg collapsed by a speculative attack. Depending on these issues, in our model, which uses a Keynesian framework augmented with a speculative foreign exchange market, it has been focused on the fundamental macroeconomic relationship between budget and trade deficits. Our theoretical model and the simulation results indicate that whether the deficit is financed by monetisation or domestic borrowing, persisting budget deficits cause the peg system to collapse. Overborrowing problems and deterioating balance sheets also play an important role on the unsustainability of the peg regime.

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    File URL: http://mpra.ub.uni-muenchen.de/1470/1/MPRA_paper_1470.pdf
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    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 1470.

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    Date of creation: 2004
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    Handle: RePEc:pra:mprapa:1470
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    1. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
    2. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
    3. Obstfeld, Maurice, 1996. "Models of Currency Crises with Self-fulfilling Features," CEPR Discussion Papers 1315, C.E.P.R. Discussion Papers.
    4. Pierre-Richard Agenor & Jagdeep S. Bhandari & Robert P. Flood, 1991. "Speculative Attacks and Models of Balance-of-Payments Crises," NBER Working Papers 3919, National Bureau of Economic Research, Inc.
    5. Guillermo A. Calvo & Enrique G. Mendoza, 1996. "Mexico's balance-of-payments crisis: a chronicle of death foretold," International Finance Discussion Papers 545, Board of Governors of the Federal Reserve System (U.S.).
    6. Maurice Obstfeld, 1984. "Speculative Attack and the External Constraint in a Maximizing Model of the Balance of Payments," NBER Working Papers 1437, National Bureau of Economic Research, Inc.
    7. Robert P. Flood & Peter M. Garber & Charles Kramer, 1995. "Collapsing Exchange Rate Regimes: Another Linear Example," NBER Working Papers 5318, National Bureau of Economic Research, Inc.
    8. Guillermo A. Calvo & Carlos A. Végh, 1994. "Inflation Stabilization And Nominal Anchors," Contemporary Economic Policy, Western Economic Association International, vol. 12(2), pages 35-45, 04.
    9. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
    10. Dornbusch, Rudiger, 1987. "Collapsing exchange rate regimes," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 71-83, October.
    11. Velasco, Andres, 1987. "Financial crises and balance of payments crises : A simple model of the southern cone experience," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 263-283, October.
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