Smirnova K. Y., Lysa O. V., Mudrenko A. A.

Oles Honchar Dnipropetrovsk National University


What is a currency crisis? A currency crisis occurs if investors lose confidence in economy and its currency and sell their investments denominated in that very currency. If we look at Thailand and Malaysia during the 90s, we can realize the impact of the sales done on a large scale in a short period of time. In other words, a speculative attack succeeds and the value of the currency falls rapidly. This is actually the archetypical currency crisis.

Private (portfolio) investors and the monetary authorities (the central bank) are two key players when crisis arises. It is assumed that the authorities want to maintain a fixed exchange rate and economic decisions are made under the belief that this fixed exchange rate will be maintained in the future. Under these circumstances, a currency crisis can be the most damaging and may ignite a full-blown financial crisis. Capital mobility is crucial for a currency crisis to occur. If investors were not able to switch from one currency to another, a currency crisis would virtually be impossible. This is one of the reasons why some economists policymakers, and anti-globalization protesters have called for the re-introduction of restrictions on international capital mobility. For instance, Malaysia decided to re-install exchange rate controls to stabilize the exchange rate in the aftermath of the currency crisis. However, such controls only make sense when blame for the currency crisis is put on speculative investors rather than economic fundamentals.

A capital account crisis is the mirror image of a currency crisis, focusing on the sudden reversal of capital flows that accompanies the currency market disruption.

Domestic equivalent for a financial crisis is a banking crisis, in which the increased fragility of a country's banking sector, potentially leading to bank runs, forces the government to intervene or banks to scale down their business. This is a potential internal channel for a financial crisis.

Most currency crises and banking crises occur in emerging markets and lead to an output loss. The costs of restructuring the financial sector for the government are substantial, ranging from funds and credit injected into the banking system to the fiscal costs of closing down banks. Although these costs are already substantial for financial currency crises, they are substantially higher for financial banking crises, and even higher for financial twin crises.

After all, the intrinsic weaknesses in the domestic financial sector might be reinforced by changes in capital flows and by a currency crisis leading to a depreciation of the domestic currency. Most recent financial crises have occurred in emerging markets, where the banking sector plays a role as intermediary in the process of channeling funds to investment opportunities. Financial crises are then mainly banking crises. Some economists argue that a banking crisis precedes a currency crisis, leading to the sequencing of a typical modern financial crisis.

The list of references:

1. International Economics: Theory, Application, and Policy / [Charles van Marrewijk, Daniel Ottens, Stephan Schuller] – United Kingdom: Oxford University Press, 2012. – 711 p.

2. Lewis Michael The Big Short: Inside the Doomsday Machine / Michael Lewis. – United States: W. W. Norton & Company, 2010. – 266 p.