Evolution, Problems and Prospects
New Horizons in Money and Finance series
Edited by David Lane
8. Predicting Russia’s currency and ﬁnancial crises Sheila A. Chapman and Marcella Mulino 1. INTRODUCTION According to one traditional approach currency crises can be explained by either ‘ﬁrst’- or ‘second-generation’ models. In canonical ‘ﬁrst-generation’ models (Krugman, 1979; Flood and Garber, 1984; Agénor et al., 1992; Flood and Marion, 2000; Dooley, 2000) crises are explained as the result of a fundamental inconsistency between domestic policies and the attempt to maintain a ﬁxed exchange rate. The original source of problems is a persistent money-ﬁnanced budget deﬁcit, with the central bank trying to peg the exchange rate using a (limited) stock of foreign exchange reserves. This policy being ultimately unsustainable, foresighted speculators anticipating the inevitable collapse generate a speculative attack on the currency well before reserves are exhausted: when reserves fall to some critical level the central bank is forced to abandon the ﬁxed exchange rate. ‘Second-generation’ models diﬀer from one another in a number of crucial aspects. In general they model situations in which crises do not follow policy inconsistencies but may be explained as self-fulﬁlling bad outcomes (Obstfeld, 1994; Cole and Kehoe, 1996; Bensaid and Olivier, 1997). Accordingly, governments face a trade-oﬀ between policy objectives and choose to abandon a pegged exchange rate once the beneﬁts of maintaining the exchange regime are outweighed by the costs of higher debt or lower output. As the cost of defending a ﬁxed exchange rate grows when expectations that it might be abandoned spread, these models envisage the possibility...
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