In the 1990s, currency crises in Europe, Mexico and Southeast Asia have drawn worldwide attention to speculative attacks on government-controlled exchange rates. To improve understanding of these events, research has proceeded on both theoretical and empirical fronts.
The purpose of this paper is to provide some perspective on this research and to relate it to earlier work in the area. The early work, now called first-generation research, responded to currency crises in developing countries such as Mexico (1973-1982) and Argentina (1978-81). These crises were preceded by overly expansive domestic policies. First-generation models show how a fixed exchange-rate policy combined with excessively expansionary pre-crisis fundamentals push the economy into crisis, with the private sector trying to profit from dismantling the inconsistent policies.
Newer models, the second generation, are designed to capture features of the speculative attacks in Europe and in Mexico in the 1990s. These attacks differ from the ones studied by the first-generation in two important ways: in the countries experiencing the attacks, the state of the business cycle and the banking system as well as borrowing constraints imposed by monetary policies in partner countries handcuffed authorities and prevented them from using traditional methods to support exchange-rate parities; the recent speculative attacks, particularly some of those in Europe, seemed unrelated to the economic fundamentals predicted by the first-generation models.
In this paper we begin in Section 1 by presenting the first-generation attack model developed by Salant and Henderson (1978), Krugman (1979) and Flood and Garber (1984b). This model has been extended widely and a survey is provided by Agenor, Bhandari and Flood (1992). We also discuss some recent extensions of the model designed to capture features of the crises in the 1990s. In Section 2 we present examples of second-generation models. In this section we also extend these models by deriving the optimal commitment to a fixed exchange rate. The section concludes with a proposal for a common cross generational framework. In Section 3 we examine empirical work that seeks to identify determinants of currency crises. Section 4 concludes.
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