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Currency Crises During the Great Recession: Is This Time Different?

Tiziano Arduini (), Giuseppe De Arcangelis () and Carlo Leone Del Bello

MPRA Paper from University Library of Munich, Germany

Abstract: During the 2007-2009 financial crisis the foreign exchange market was characterized by large volatility and wide currency swings. In this paper we evaluate whether during the period of the Great Recession there has been a structural break in the relationship between fundamentals and exchange rates within an early-warning framework. This is done by extending the original data set by Kaminsky and Reinhart (1999) and including not only the most recent period, but also 17 new countries. Our analysis considers two variations of the original early-warning system. First, we propose two new methods to obtain the probability distribution of the early-warning indicator (conditional on the occurrence of a crisis) – one fully parametric and one based on a novel distribution-free semi-parametric approach. Second, we compare the original early-warning indicator with a core indicator that includes only “pseudo-financial variables” (domestic credit/GDP, the real exchange rate, international reserves and the real interest-rate differential) and we evaluate their performance not only for currency crises during the Great Recession, but also for the Asian Crisis. All tests make us conclude that “this time is different”, i.e. early-warning systems based on traditional macroeconomic variables have not only failed to forecast currency crises during the Great Recession, but have also significantly worsened with respect to the period of the Asian crisis.

Keywords: Early Warning Systems; Exchange Rates; Semi-parametric Meth- ods (search for similar items in EconPapers)
JEL-codes: F30 C14 F47 F31 (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-ifn, nep-mon and nep-sea
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