Fiscal Deficits and Currency Crises
37 Pages Posted: 8 May 2003
Date Written: May 2003
This paper investigates currency and financial crises in an optimizing general equilibrium model. It is shown that a rise in current and expected future budget deficits generates a real exchange rate appreciation and a decumulation of external assets, leading up to a currency crisis when foreign reserves approximate a critical level. Strong empirical support for our model is obtained by a probit estimation for Latin American and Asian countries.
Keywords: budget deficits, foreign exchange reserves, currency crises
JEL Classification: F31, F32, F41, E52, E62
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