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On the Changing Nature of Currency Crises

  • Korkut Erturk


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    In the crises of 1980s, ever-increasing current account deficits, fueled by unsustainable economic expansions, were invariably the main cause of rising devaluation risk that eventually led to the reversal of capital flows. By contrast, in the 1990s, considerations of financial fragility and sovereign risk have instead become the main determinants of capital flow reversals. The paper argues that portfolio dynamics driven by speculative expectations have been the decisive force in causing financial fragility. Thus rather than seeing the build up of financial risks as the cause of sudden shifts in market sentiment, it might be more meaningful to think of both as being caused by speculative dynamics. It is argued that capital inflows financing speculative asset positions are liable to give rise to endogenous capital flow reversals. Capital inflow continues as long as asset prices are expected to rise. However, this can only be temporary since asset prices cannot keep increasing indefinitely and an abrupt reversal of capital flows ensues once it is taught that asset prices have peaked.

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    Paper provided by University of Utah, Department of Economics in its series Working Paper Series, Department of Economics, University of Utah with number 2003_02.

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    Length: 21 pages
    Date of creation: 2003
    Date of revision:
    Handle: RePEc:uta:papers:2003_02
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