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Prospective deficits and the asian currency crisis

  • Burnside, Craig
  • Eichenbaum, Martin
  • Rebelo, Sergio

The authors argue that the recent Asian currency crisis was caused by large prospective fiscal deficits associated with implicit bailout guarantees to failing banking systems. They 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 deficit rises. This is true regardless of the government's foreign reserves position or the initial level of its debt. The government cannot prevent a speculative attack but it can affect its timing. The longer the delay, the higher inflation will be under flexible exchange rates. The authors present empirical evidence in support of the two key assumptions of their model: 1) Large losses in the banking sector were associated with large increases in Asian governments'prospective deficits. 2) The public knew that the banks were in trouble before the currency crisis.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2174.

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Date of creation: 30 Sep 1999
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Handle: RePEc:wbk:wbrwps:2174
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  1. Maurice Obstfeld, 1986. "Speculative Attack and the External Constraint in a Maximizing Model of the Balance of Payments," Canadian Journal of Economics, Canadian Economics Association, vol. 19(1), pages 1-22, February.
  2. Michael P. Dooley, 1997. "A Model of Crises in Emerging Markets," NBER Working Papers 6300, National Bureau of Economic Research, Inc.
  3. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 2001. "Prospective Deficits and the Asian Currency Crisis," Journal of Political Economy, University of Chicago Press, vol. 109(6), pages 1155-1197, December.
  4. Maurice Obstfeld & Kenneth Rogoff, 1995. "The Mirage of Fixed Exchange Rates," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 73-96, Fall.
  5. 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.
  6. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, vol. 40(3-5), pages 1037-1047, April.
  7. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
  8. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March.
  9. Timothy D. Lane & Marianne Schulze-Gattas & T. M. Tsikata & Steven Phillips & Atish R. Ghosh & A. Javier Hamann, 1999. "IMF-Supported Programs in Indonesia, Korea and Thailand," IMF Occasional Papers 178, International Monetary Fund.
  10. 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.
  11. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
  12. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "Paper tigers?: A model of the Asian crisis," European Economic Review, Elsevier, vol. 43(7), pages 1211-1236, June.
  13. Allan Drazen & Elhanan Helpman, 1987. "Stabilization with Exchange Rate Management," The Quarterly Journal of Economics, Oxford University Press, vol. 102(4), pages 835-855.
  14. Rebelo, Sergio & Xie, Danyang, 1999. "On the optimality of interest rate smoothing," Journal of Monetary Economics, Elsevier, vol. 43(2), pages 263-282, April.
  15. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  16. Sweder van Wijnbergen, 1991. "Fiscal Deficits, Exchange Rate Crises and Inflation," Review of Economic Studies, Oxford University Press, vol. 58(1), pages 81-92.
  17. 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.
  18. 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.
  19. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  20. 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.
  21. Kaminsky, Graciela & Lizondo, Saul & Reinhart, Carmen M., 1997. "Leading indicators of currency crises," Policy Research Working Paper Series 1852, The World Bank.
  22. 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.
  23. 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.
  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. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  26. 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.
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