Currency Crisis in Developing Countries

Currency Crisis in Developing Countries

Christopher Boachie (Central University College, Ghana)
DOI: 10.4018/978-1-4666-9484-2.ch010
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Currency crises have been the subject of an extensive economic literature, both theoretically and empirically. The purpose of this chapter is to examine and investigate the causes of currency and associated crises, evaluates the accuracy of empirical models in predicting crises, and review works on measuring the consequences of crises on the real economy. It is a cross sectional survey study and used of secondary data on the causes of currency and associated crises, and challenges in avoiding these crises. The study reveals that reduce output, financial liberalization, capital and current accounts, the real economy and macroeconomic conditions are some of the indicators of currency crisis. A key cost of currency crisis is forgone output. EWS models estimate probabilities of crises to occur. The implications are that currency crisis negatively affects the economy needs to be predicted and managed appropriately.
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1. Background

There is an over-abundance of theoretical models and practical studies which analyse financial crises in general and predicting tools and models of those crises in particular. Studies attempting to identify the causes, origins, and consequences of currency crises (Kaminsky & Reinhart, 1999; Jotzo, 1999; Zhuang, 2002; Bongini, Laeven, & Majnoni, 2002; Sy, 2003; Apoteker & Barthélamy, 2005; Kaminsky, 2006; Bussiere & Fratzscher, 2006; Andreou, 2007; Cipollini & Kapetanios, 2009) mainly focus on macroeconomic factors, vulnerability indicators, probability of crises, and exchange market pressure (EMP) index, that can predict those crises.

Key Terms in this Chapter

Credit Rating Agency: A company that rates the quality of bonds and other financial securities. The rating gives a lender or investor an indication of the probability that the issuer of the bond or other security will be able to pay back the borrowed funds – that is, the rating assesses the probability of default . A poor credit rating indicates a high risk of default, thus leading the lender or investor to charge a higher interest rate or refuse to make the transaction. Well-known rating agencies include Moody’s, Standard & Poor’s, and Fitch Ratings. Credit rating agencies must meet standards established by the Securities and Exchange Commission.

Macro-Economic Policies: The major policies used by governments (eg monetary and fiscal policies) to influence the level of employment, the price level, economic growth and the balance of payments.

Contagion: When economic problems in one country spread to another.

Emerging Markets: The financial markets of developing economies or industries.

Keynesian Policies: Economic doctrine associated with British economist John Maynard Keynes, which maintains that supply and demand in economies do not automatically reach equilibrium; government intervention is needed to manage demand and sustain employment.

Pegged Exchange Rates: A regime in which the government or central bank announces an official value of its currency and then maintains the actual market rate within a narrow band above and below that by means of exchange market interve ntion

Gross Domestic Product (GDP): It is the total value of goods and services produced domestically by a country during a year.

Market Failure: Situation where a market does not achieve the optimal allocation of resources, eg as a result of imperfect information, anti-competitive practices or abuse of market power.

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