Krugman 1999 presented a new theory of currency crisis, socalled a thirdgeneration crisis model, which is different in various aspects from other currency crisis models. This model uses economies of scale, differentiated products and heterogenous preferences to explain intraindustry trade. A model of balanceofpayments crises stone center on socio. Understanding krugmans thirdgeneration model of currency. Cagans equation of exchange equations 5 and 6 show the relation between money and exchange rate. Currency regimes, capital flows, and crises paul krugman princeton university paper presented at the 14th jacques polak annual research conference hosted by the international monetary fund washington, dcnovember 78, 20 the views expressed in this paper are those of the authors only, and the presence. The canonical currency crisis model, as laid out initially by krugman 1979 and refined by flood and garber 1984, was designed to mimic the commod ity board story. Theoretical models of currency crises are often categorized as first, second, or thirdgeneration, though many models combine elements of more than one generic form. Prediction of currency crises using a fiscal sustainability. Paul krugman is assistant professor of economics, yale university. Krugman, 1979 and its extension models flood and garber 1984. The dramatic currency crisis that culminated in the august 1993 widening of exchangerate bands. Firstgeneration crisis models, exemplified by krugman 1979 and flood and garber 1984 essentially viewed a central banks efforts to peg an exchange rate using reserves as being similar to a commodity agencys efforts to peg a resource price using its stockpile. A simple example from obstfeld eer 1996 helps to clarify this point.
In both firstgeneration models such as krugman 1979 and flood and garber 1984 and secondgeneration models such as obstfeld. The mother of all currency crises paul krugman blog. The timing and size of bankfinanced speculative attacks. This in turn allows for a consideration of the effects of banking sector vulnerabilities on the speed and timing of a currency collapse. The upward trend in the shadow price of foreign exchange the price that would prevail after the speculative attackwas supplied by as. The socalled firstgeneration research on currency crises presented a response to the observed foreign exchange turmoil in the 1970s in developing countries such as mexico 19731982 and. Krugman is the author or editor of 20 books and more than 200 papers in.
A seminal paper by krugman 1979 provided a convincing theore. What differentiates the new currency crisis literature from the classi cal literature exemplified by krugman 1979 and flood and garber 1984. Paul krugman january 1999 balance sheets, the transfer problem, and financial crises this is a preliminary draft, prepared for the festschrift volume in honor of robert flood for the founding fathers of currency crisis theory a fraternity among whom bob flood holds a place of high honor the emerging market crises of 1997. After salanthenderson model was drafted krugman 1979 proposed to apply the model to the analysis of speculative attacks not against commodity boards trying.
On currency crises and contagion european central bank. The major early contributions in this field have come from salant and henderson salant and henderson 1978, krugman 1979 and flood and garber 1984. The firstgeneration models of a currency crisis developed by krugman 1979 and flood and garber 1984 rely on government debt and the perceived inability of the government to control the budget as the key causes of the currency crisis. The logic of currency crises university of california, berkeley. The future generations of my country will be born into high rates of credit that have fallen upon the country. The canonical currency crisis model, as laid out initially by krugman 1979 and refined. Global financial systems chapter 12 currency crisis models. First generation models of currency crises, starting with krugman 1979 and flood and garber 1984a.
A model of balanceofpayments crises paul krugman journal of. A currency crisis is a speculative attack on the foreign exchange value of a currency, resulting in a sharp depreciation or forcing the authorities to sell foreign exchange reserves and raise. Paul krugman a model of balanceofpayments crises introduction a government can peg the exchange value of its currency in a variety of ways. Klein tufts university the fletcher school of law and diplomacy jay c. A dictionary of economics, 2nd edition february 2007 there have been many currency crises during the postwar era see kaminsky and reinhart, 1999. Krugman1979a model of bop a model of balanceofpayments. Krugman 1979 showed that in a world of perfect foresight, the moment of transition between the fixedrate regime and its successor generally involves a speculative attack in. Download for offline reading, highlight, bookmark or take notes while you read currency crises. Second, a panel data analysis confirms the robustness of these results for a sample of 24 open emerging markets. Theoretical models of currency crises have evolved greatly over time. Since the global financial crisis, global debt has reached an alltime high of roughly 230 percent of gdp. In a countrywith highly developed financial markets it can use openmarket operations, interventionin the forwardexchange market, and direct operations in foreign assets to defend an exchange paritysee 2 for an analysisof central bank operations and. The canonical currency crisis model, as laid out initially by krugman 1979 and ref. First generation models salant and henderson, 1978.
Paul robin krugman is an american economist, liberal columnist and author. Currency crises national bureau of economic research. Within a week our external debt has risen to the highest ever. The evidence and impact of financial globalization, 20. One important difference is a change in the macroeconomic and policy models that are used to describe crisis prone countries. Paul krugman january 1999 balance sheets, the transfer. A currency crisis is a type of financial crisis, and is often associated with a real economic crisis. A currency crisis is defined as a speculative attack on the foreign exchange value of a currency, resulting in a sharp depreciation or forcing the authorities to sell foreign exchange reserves and raise domestic interest rates to defend the currency.
Reconciling re models with currency crises krugman, 1979. In the most basic model of currency crisis, authorities pursue unsustainable macroeconomic policies that must eventually force a fixed exchange rate to be abandoned. In 1979 he published a paper on currency crises in the journal of money, credit, and banking showing that fixed exchange rate regimes are unlikely to end smoothly. Currency crisis models currency crises have been the subject of an extensive economic literature, both theoretical and empirical. The recent currency crises in latin america and asia have hit countries with strong macroeconomic. Krugman has also been influential in the field of international finance. Part of the lecture notes in economics and mathematical systems book series lne. Krugman s 1979 model shows that, under a fixed exchange rate, domestic credit expansion in excess of money demand growth leads to a gradual but persistent loss of international reserves and, ultimately, to a speculative attack on the currency.
Oct 26, 2008 our economy is draining fast and the current currency crisis makes it worse. Lecture notes in economics and mathematical systems, vol 527. Paul krugman s 1994 provocative critique of east asian growth suggested a slowdown in growth, not a collapse, a point that krugman himself made clear in the fall of 1997. F31, f32, f41 for the founding fathers of currency crisis theorya fraternity among whom bob flood holds a place of high honorthe emerging market crises of 19978 inspire both a sense of vindication and a sense of humility. This paper presents a model to study the dynamics of a currency crisis. Article in press discrete devaluations and multiple equilibria in. He is professor of economics and international affairs at the woodrow wilson school of public and international affairs, princeton university, centenary professor at the london school of economics, and an oped columnist for the new york times. This provides the motivation for the incorporation of a fragile banking sector within a krugman 1979 type framework. In these models, the government runs a persistent scal decit, which leads to sustained reserve losses under a xed exchange rate regime. In this article we adopt statistical methods such as the signal approach and econometric methods such as the probit model for identifying and evaluating the currency crisis. And the peg is abandoned because everybody attacked the currency. These models argue that a speculative attack on the domestic currency can result from an increasing current. But there are strong parallels between the kinds of crises we actually have been experiencing and what those of us in the currency crisis biz call thirdgeneration crises.
Continuing relevance the basic assumption is that a currency crisis stems from monetary or. Krugman 1979 and flood and garber 1984 consider two models with uncertainty. The novel feature of the immediate devaluation with long0term debt is that the. The recent epidemic of banking and currency crises has led researchers to consider the role that unhealthy. Balance sheets, the transfer problem, and financial crises. Paul krugman s currency and crises is a collection of 11 academic essays on international monetary economics written between the late 1970s and 1980s. This pdf is a selection from an outofprint volume from the national bureau of economic research. I apply this to krugmans 1979 balance of payments crisis model, where he argued that there is. The results suggest that the latin american crisis in 199495 and the asian crisis of 1997 spread across emerging markets not primarily. Developed in 1980s, these models echoed the prevalent views about currency crises for more than a decade.
The socalled firstgeneration research on currency crises presented a. During a currency crisis the value of foreign denominated debt will rise drastically relative to the declining value of the home currency. This paper estimates a survival model to identify the role of macroeconomic fundamentals on the likelihood and the timing of a currency crisis for mexico during. This attack immediately depletes reserves and forces the authorities to abandon the parity. Krugman adapted their model for the foreign exchange market, resulting in a 1979 paper on currency crises in the journal of money, credit, and banking, which showed that misaligned fixed exchange rate regimes are unlikely to end smoothly but instead end in a sudden speculative attack. Krugman 1979 claims that a currency crisis is caused by a large budget deficit that is financed by credit expansion.
Andrew kindman currency crisis ews page 4 theoretical models of crises, their origins and processes. It is shown that when banks finance the crisis, an anticipated collapse occurs sooner an. A currency crisis is an episode in which the exchange rate depreciates. Typology of currency crisis models firstgeneration models secondgeneration models thirdgeneration models typology early views. In the former, the local government may want to spend a fraction of its foreign reserves to defending the currency with certainty, while there is a positive. Similarly, van wijnbergen 1991 demonstrates how the resulting fiscal inconsistencies lead to international reserve losses and forced devaluations as well as. Goldberg federal reserve bank of new york michael w. The old currency crisis models were essentially seignoragedriven. A currency crisis raises the probability of a banking crisis or a default crisis. Jun 01, 2015 the sudan currency crisis in 2012 occurred when the sudanese pound lost 66 percent of its value against the us dollar. Obstfeld 2000 international economics fifth edition addison.
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