The Debt Crisis And Currency Crisis,

The sovereign debt crisis originated in Greece in late 2009 and then rapidly expanded to other European members of the euro economy countries, such as Spain, Portugal and Ireland. The euro zone sovereign debt crisis has triggered global concerns about the breakout of the euro zone currency crisis. Does the sovereign debt crisis interrelate with the currency crisis? If they do, what kind of interrelations could exist between the sovereign debt crisis and the currency crisis?The previous researches had typically treated currency and debt crises as isolated events, however, the simultaneous occurrence of currency and sovereign debt crises is empirically a rather frequent phenomenon. Nevertheless the literature on currency crises and sovereign defaults usually neglects the question of how the two types of crises might be related. To further explore the relationship between currency and sovereign debt crises, the essay establishes a simple theoretical model which combines the welfare optimizing government's incentives and its budget constraints. After our study with the model, We get a conclusion that the two could be positively related in some cases, while in other cases, they could be negatively related.In order to empirically find out the relationship between currency and debt crises, we analyze the crisis data for 45 developing countries over the period 1977-2005 with Probit model. Then we find that the occurrence of a currency crisis significantly increases the risk of a contemporaneous debt crisis and vice versa. We further find one-year lagged currency crises can significantly help predict debt crises, while one-year lagged debt crisis only has weak power in predicting currency crises.The innovation of this paper is we make an in-depth study on the link between currency and debt crises by both theoretical analysis and empirical analysis. Our analysis will deepen the understanding of relationship of the two crises.