The Causes and Consequences of a Currency Crisis Essay

The Causes and Consequences of a Currency Crisis - Essay ExampleThis creates inflation and a current account deficit, which may lead investors to doubt the sub estimate peg. Speculators eventually mount an attack--that is, they demand irrelevant reserves in exchange for the domestic coin. To defend the peg, the monetary authorities sell off foreign exchange reserves. When the reserves fall to a certain point, the government is faced with a choice should it break its external promise (to keep the exchange rate fixed) or keep its internal political constituents happy (by not raising taxes or cutting spending) Governments usuallychoose internal objectives over external constraints that is, in that respect is a currency crisis. A model like this works well in helping to understand the breakdown of inflationary economies, like Russia in 1998. precisely such models dont help understand recent crises in Asia. Most Asian countries had admirable monetary and fiscal policies that were vi ewed as being sustainable.The second model views currency crises as shifts between different monetary policy equilibria here speculative attacks can be self-fulfilling even against countries with sound policies. In these models, market speculators initiate attacks base on their beliefs about the willingness of policymakers to resist pressure on the exchange rate. When markets perceive that conditions, such as high unemployment or a weak banking system, compromise the exchange banks willingness to defend the currency peg by raising interest rates, speculative attacks are more likely to succeed.When a country faces a currency crisis, otherwise countries are affected mainly because of international trade. Thailand faced a monetary crisis which led to Malaysia and Indonesias currency situation as these countries were Thailands main trade competitors. Hence, trade is regional so currency crises are regional. Recessions are associated with currency crises and Last Name 3lead to a fall in imports. Trade flows are stop as one countrys imports fall causes another countrys exports to decrease. Once trade flows are disrupted, major issues occur as free trade is a wonderful thing. on that point are many models that attempt to explain the phenomenon of how a financial crisis is formed. Chang and Velasco (1998) suggest a useful model should consist of the following features, It must not curse on government misbehavior to generate the crisisIt must be general enough to accommodate a wide variety of macroeconomic circumstancesIt must be specific enough to explain why in some of these macroeconomic scenarios a crisis occurs, and in some it does notIt must account for the high observed correlativity between exchange rate collapses and banking crisesIt must replicate the puzzling fact that the punishment is much larger than the crimeThe transferring of information in international financial markets can cause most of the information to become trapped. Minute changes in inf ormation can cause incredible behaviour by international investors. During a currency crisis, governments tend to expropriate foreign funds in an attempt to raise funds. (Chari and Kehoe, 1997). Their model implies that only governments with weak reputations are subject to volatile seat of government flows. Thailand faced incredible external (foreign) debts. As its debts increased, creditors wondered if it could meet its obligations. Hence, supply