(IR)RELEVANCE OF EXISTING CURRENCY CRISES THEORY TO THE EAST ASIAN COLLAPSE by

This paper surveys the theoretical literature on currency crises in order to determine the usefulness and limitations of existing models in understanding the recent currency crises, particularly the one in East Asia, which began with the forced devaluation of the Thai baht in July 1997. One may delineate three broad groups of models. The ‘first generation’ models are based on the canonical paper by Krugman (1979). He showed how the presence of rational, forward looking speculators would hasten the breakdown of a fixed exchange rate regime that was inherently unsustainable, due to the government’s attempt at financing a persistent fiscal deficit through monetization. ‘Second generation’ models of currency crises are broadly all those that generate non-unique equilibra, and are therefore commonly referred to as ‘multiple equilibra’ models. Calvo (1995) and Calvo and Mendoza (1996) have recently explicated a model that illustrates how the existence of a number of investment opportunities worldwide could lead to boom-bust cycles in capital flows. While this socalled ‘capital-crisis’ model may be considered a sub-set of the second generation models in that it is ‘self-fulfilling’, we highlight some important conceptual and policy differences between the two, thus possibly warranting a separate classification.