Integration in the Global Economy
New Horizons in Money and Finance series
Edited by Suthiphand Chirathivat, Emil-Maria Claassen and Jürgen Schroeder
Chapter 7: Causes of the currency crisis: Indonesia, Korea, Malaysia, the Philippines and Thailand
Chayodom Sabhasri, June Charoenseang and Pornkamol Manakit 7.1 THE CAUSES OF EAST ASIA’S CRISIS1 The causes of Asia’s problems are complex. Economists have developed models of currency crises that fall into two broad categories: ‘first generation’ and ‘second generation’ models. The ‘first generation’ models explain crises as the result of fundamental inconsistencies in domestic policies. Therefore, the ‘first generation’ models predict that a deterioration in the fundamentals is indicated by overvalued real exchange rates, large current account and trade deficits, a high depletion rate of international reserves, growing budget deficits, high rates of monetary growth, high inflation, and rising domestic interest rates. ‘First generation’ models of speculative attacks emphasize that the acceleration in domestic credit expansion related to the monetization of fiscal deficits is the key factor that explains the loss of reserves that leads to a currency crisis. In other words, a currency crisis in a country with a fixed exchange rate is caused by an excessive budget deficit. To finance this deficit, the government prints money whereas its central bank must commit to defending the exchange rate. Such defense is possible only if it has a sufficient stock of foreign exchange reserves. However, as the government continues printing money, reserves will fall, as the private sector would rather hold other currencies and thus exchange local currencies for foreign currency. By contrast, the interaction in expectations directly influences macroeconomic policy decisions in ‘second generation’ models of currency crises. These models provide a generic feature of theoretical macroeconomic policy models...
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