On the Changing Nature of Currency Crises

Korkut Erturk

Working Paper Series, Department of Economics, University of Utah from University of Utah, Department of Economics

Abstract: In the crises of 1980s, ever-increasing current account deficits, fueled by unsustainable economic expansions, were invariably the main cause of rising devaluation risk that eventually led to the reversal of capital flows. By contrast, in the 1990s, considerations of financial fragility and sovereign risk have instead become the main determinants of capital flow reversals. The paper argues that portfolio dynamics driven by speculative expectations have been the decisive force in causing financial fragility. Thus rather than seeing the build up of financial risks as the cause of sudden shifts in market sentiment, it might be more meaningful to think of both as being caused by speculative dynamics. It is argued that capital inflows financing speculative asset positions are liable to give rise to endogenous capital flow reversals. Capital inflow continues as long as asset prices are expected to rise. However, this can only be temporary since asset prices cannot keep increasing indefinitely and an abrupt reversal of capital flows ensues once it is taught that asset prices have peaked.

Keywords: Currency crises; portfolio investment; asset prices; capital flow reversal (search for similar items in EconPapers)
JEL-codes: F02 F36 G15 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2003
New Economics Papers: this item is included in nep-cwa, nep-ifn, nep-mon, nep-pke and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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