Analytic models of currency crisis.

An NBER Conference on Analytic Models of Currency Crisis, organized by Research Associate Paul Krugman of MIT, took place in Cambridge on February 5. The following papers were discussed:

Ricardo J. Caballero, NBER and MIT, "Emerging Market Crises: An Asset Market Perspective" (NBER Working Paper No. 6843)

Discussant: Andres Velasco, NBER and New York University

Roberto Chang, Federal Reserve Bank of Atlanta, and Andres Velasco, "Financial Fragility and the Exchange Rate Regime" (NBER Working Paper No. 6606)

Discussant: Maurice Obstfeld, NBER and University of California, Berkeley

Guillermo Calvo, University of Maryland, "Understanding the Russian Virus"

Discussant: Carmen Reinhart, University of Maryland

Giancarlo Corsetti, Yale University, Paolo A. Pesenti, Federal Reserve Bank of New York, Nouriel Roubini, Council of Economic Advisers, and Cedric Tille, Princeton University, "Competitive Devaluations: A Welfare-Based Approach" (NBER Working Paper No. 6889)

Discussant: Roberto Rigobon, MIT

V. V. Chari, the University of Minnesota, and Patrick J. Kehoe, Federal Reserve Bank of Minneapolis, "Hot Money" (NBER Working Paper No. 6007)

Discussant: Paul Krugman

Caballero notes that although internal policy mismanagement can be cited in most recent emerging market crises, it seldom accounts fully for the severity of these crises. Almost invariably, the reluctance of international investors to provide the resources that would limit the extent of the reversal plays a key role in bringing a previously overheated economy to a costly halt. Domestic assets depreciate dramatically, and otherwise solvent investment projects and production, especially in the nontradable goods sector, lack financiers and are shut down. The ultimate reason for this breakdown is the inadequacy (real or perceived) of the country's international collateral. Caballero shows that this insufficiency and its consequences stem from microeconomic contractual problems. Fire sales of domestic assets arise naturally as the result of desperate competition for scarce international collateral. The contractual problems also lead to insufficient domestic collateral, which restricts the transfer of any surplus arising from the use of international collateral by its users and providers.

Chang and Velasco present a simple model that can account for the main features of recent financial crises in emerging markets. The international illiquidity of the domestic financial system is at the center of...