Averting Currency Crises: The Pros and Cons of Financial Openness

Abstract:     
We identify the benefits and costs of financial openness in terms of currency crises based on a novel quantification of the systemic impact of currency (financial) crises. We find that systemic currency crises mainly exist regionally, and that financial openness helps diminish the probability of a currency crisis after controlling for their systemic impact. To clarify further the effect of financial openness, we decompose it into the various types of capital inflows. We find that the reduction of the probability of a currency crisis depends on the type of capital and on the region. Finally yet importantly, we find that monetary policy geared towards price stability, through a flexible inflation target that takes into account systemic impact, reduces the probability of a currency crisis.

Number of Pages in PDF File: 42

Keywords: Exchange market pressure, systemic risk, capital flows

JEL Classification: F31, F36, F42, E52

working papers series