Emerging Market Currency Crisis Theory, Experience And Governance

For last decades currency crisis bothered the international economy—speculation attack ended the"Bretton-Wood System", the fixed exchange rate of Latin-America provided targets for speculation attacks in 1980s, Euro-monetary system also faced currency crisis in 1992-1993.Specially the Eastern-Asia financial crisis happened in 1997, then literatures focused on currency crisis became hot argument both on economists and policy makers. Obviously currency crisis is a huge research area, but this paper concentrates on the following field.Emerging markets can suffer severe contractions during currency crisis when capital inflows suddenly reverse. What is the right monetary policy response to this event? Answering this important question requires understanding the mechanisms through which monetary policy can affect sudden stops and their consequences.Much of recent literature on emerging markets crisis highlights the limited financial development of these economies and the severe credit squeeze experienced by local firms during crises. From this structure, two opposing arguments are commonly made regarding optimal monetary policy. Extrapolating from developed economy credit channel analysis, some advocate an expansionary monetary policy to offset the effect of the credit squeeze during downturns. While, others advocate a contractionary monetary policy and dogged defense of the exchange rate during crises. Proponents of the latter view do not disagree upon the centrality of the credit channel mechanism, but argue that a depreciating exchange rate will have dramatic effect in the credit channel mechanism, through a deterioration in borrower's balance sheets. The argument is that this effect is most likely to happen when the economy is dollarized and when inflation-credibility is limited.The starting point of this analysis is the observation from Caballero...