CURRENCY CRISES

1
CURRENCY CRISES

• POP IULIA

2
Introduction

• Importance and objectives of currency crises
  models
• Empirical results an effective warning system
  should consider a broad variety of indicators

3
SOURCES OF SPECULATIVE ATTACKS

• The First-Generation Models - Latin American
  crises in the 1980s
• Krugman (1979) and Flood and Garber (1984)
• The approach inconsistency between a fixed
  exchange rate rule and the pursuit of domestic
  policies such as monetising large fiscal and
  current account deficits
• The sudden speculative attacks on currencies
  are rational

4
SOURCES OF SPECULATIVE ATTACKS

• The Second-Generation Models - European Exchange
  Rate Mechanism crises 1992-1993
• Obstfeld (1994,1996)
• The approach dynamic interactions of market
  expectations and the conflicting objectives of
  the government gt self-fulfilling run on the
  domestic currency
• Multiple equilibria and herding behavior by
  investors

5
How do these models perform empirically?

• The empirical literature has not been able to
  determine whether first or second-generation
  models are better explaining currency crashes
• Indicators such as the real exchange rate,
  foreign reserves and a weak banking system are
  useful in predicting crises

6
SOURCES OF SPECULATIVE ATTACKS

• The Third-Generation Models Asian Crisis
  1997-1998
• Eichengreen, Rose and Wyplosz (1995), Sachs,
  Tornell and Velasco (1996), Kaminsky, Lizondo and
  Reinhart (1997, 1998)
• Focus on a broader set of fundamentals
  political, institutional, financial variables
• What indicators worked best
• international reserves
• real exchange rate
• credit growth
• export performance
• domestic inflation

7
THE NONPARAMETRICAL SIGNALS APPROACH

• It involves monitoring the evolution of a number
  of economic variables when one of these
  variables deviates from its normal level beyond
  a threshold, this is taken as a warning signal
  about a possible currency crisis within a
  specified period of time
• The definition of a currency crisis a situation
  in which an attack on the currency leads to a
  sharp depreciation of the currency, a large
  decline in international reserves, or a
  combination of the two.

8
THE METHOD

• The countries
• Hungary Austria
• Romania Germany
• Poland Greece
• Slovak Republic Italy
• Turkey Spain
• Russian Federation
• The sample length 1994-2000
• The signaling horizon 24 months

9
THE EXCHANGE MARKET PRESSURE INDEX

• For each country, crisis is identified ex post by
  the behavior of an index
• where T (threshold level) is set at three
  standard deviations from the mean
• where monthly percentage changes in the
  exchange rate
• where monthly percentage changes in the
  international reserves
• The weights are chosen so that the two components
  of the index have the same variance.

10
THE EXCHANGE MARKET PRESSURE INDEX- results -

• Country Number of Crises Period
• Hungary 0 -
• Romania 2 January 1997
  February 1997
• Poland 1 August 1996
• Slovakia 2 March 1999
• 
  May 1999
• Turkey 1 January 1997
• Russia 2 August 1998
• 
  September 1998
• Austria 0 -
• Germany 0 -
• Greece 0 -
• Italy 1 February 1998
• Spain 0 -

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THE EXCHANGE MARKET PRESSURE INDEX

• Romania
• The results are consistent with the IMF Country
  Report 01/16 for Romania.
• The evolution of the index does not reflect the
  1998 contagion effects of the Russian financial
  crisis and the 1999 pessimistic expectations of
  the market .

12
THE INDICATORS

• The choice of indicators was dictated by
  theoretical considerations and by the
  availability of information on a monthly data.
  They are
• exports (in U.S. dollars)
• imports (in U.S. dollars)
• monetary aggregate M1
• real exchange rate
• gross international reserves
• For all these variables the indicator on a given
  month was defined as the percentage change in the
  level of the variable with respect to its level a
  year earlier gt the comparability of units across
  countries, it eliminates the seasonality effects

13
DEFINITIONS

• Signaling horizon the period within which the
  indicator would be expected to have an ability
  for anticipating crises, and is defined a priori
  as 24 months.
• Signals an indicator is said to issue a signal
  whenever it departs from its mean beyond a given
  threshold level.
• Thresholds are defined in relation to
  percentiles of the distribution of observations
  for each indicator. While the percentile used as
  reference (20) is uniform across countries, the
  corresponding indicator-specific thresholds are
  different.

14
DEFINITIONS

• The performance of each indicator is examined in
  terms of the following matrix
• Crisis No
  crisis
• (within 24
  months)
• Signal was issued A B
• No signal was issued C D
• A no. of months in which the indicator issued a
  good signal
• B no. of months in which the indicator issued a
  bad signal or noise
• C no. of months in which the indicator failed
  to issue a signal
• D no. of months in which the indicator
  refrained from issuing a signal

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EMPIRICAL RESULTS- information on the
performance of individual indicators is presented
in the next table -

• Final Results
• - tendency of indicator to issue good signals
• RER
• Imports
• Exports
• Reserve
• - tendency of indicators to issue bad signals
• Imports
• Exports
• - noise/signal ratio
• Reserves
• RER

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ROMANIA - EMPIRICAL RESULTS

• 1. The outcome of the analysis is consistent with
  the theoretical and empirical currency crises
  literature
• 2. The real exchange rate and international
  reserves are the indicators with the highest
  power of anticipating a crisis situation on the
  foreign exchange market