Currency crisis model 3

Question 1

Background currency crisis model 3

Answer 1

East asian crisis 1997: responsible fiscal and monetary policy
Massive speculative attacks: **contagion **to Brasil and Russia
Precautionary reserves accumulation: large CA suprlus, large CA imbalance
Had strong fundamentals before crisis

Question 2

Consequence of the EAC

Answer 2

Huge foreign reserves accumulation in neigbour countries

Question 3

Schets start 3e generation model

Answer 3

Small open economy
2 groups: gamma en 1-gamma
row na acces to capital markets
impliciete bail out door overheid

Question 4

Elite agents

Answer 4

Firms borrow internationally to ivest in capital
Face uncertainty about production
Bail-out guerantees

Question 5

Overview

Answer 5

Make losses - borrow more
Overinvest and large debt
Investors allow to overinvest because governemt
Debt burden higher than what governement can do? –> investors pull out

Question 6

Optimal capital choice

Answer 6

E(afgeleide y naar k t+1) = rt
Expected return on capital = intrest rate
Because of government, they overinvest

Question 7

International lending

Answer 7

Rational investors would not lend (Ponzi scheme)
F grows at a rate greater than r

Question 8

Show me the money constraint

Answer 8

Intern investors lend untill they believe that the governemt can guarantee: B > gamma F
Gamma : confidence treshold

Question 8

Show me the money constraint

Answer 8

Intern investors lend untill they believe that the governemt can guarantee: B > gamma F
Gamma : confidence treshold

Question 9

5 steps dynamic of the crisis

Answer 9

1. Show me the money violated: investors don’t lend money - governement bails out
2. (1-gamma)Ft can not be recovered with reserve so it’s Bt+1 debt - needs to cover this with future taxes or seignorage
3. No more bail out guarantees, K goes down, furture tax income go down
4. Government finance: lower investment –> less capital inflow, lower tax revenue –> expectat of future moet growth –> attack on the currency
5. Currency crisis: devaluation worsens the debt burden: T in dom and Debt in foreign

—> financial crisis

Question 10

Rational expectations

Answer 10

Agents expect those events:
1. Firms prevent bij investing less? No because indiv best to overinvest
2. Do something before the crisis?

Question 11

General lessons 1e generation model

Answer 11

Unsustainable fiscal policy loss in confidence –> choose austarity or printing money
Prevent: EMU set of rules to keep debt substan (not over 60 gdp)
Good idea, bad uitvoeringn
Frank en duitsland gesoon genegeerd

Question 12

General lessons 2nd generation model

Answer 12

Currency pegs can fall even with sound policy
Give governemnt choice, gevaarlijk
Solution: no national currency, so no attacks
But nog true; devaluation is exit, exit and devaluation is redenomonation of debt, no attack on currency but sovereign bonds
= partial default