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Speculative currency crises seem to have become a common and inevitable phenomenon in the international monetary system. Against this background, various approaches have been developed by economists to cover the broad range of situations in which balance-of-payments crises occurred. Anja Zenker provides a comprehensive insight into the body of theoretical and empirical literature about currency speculation in fixed exchange rate regimes. The author discusses different generations of theoretical models and their empirical relevance in recent currency crises. Moreover, she considers diverse policy options which attempt to avoid speculative attacks on exchange rate pegs.



1. General Remarks

The choice of the exchange rate system is one of the most fundamental decisions a country has to make when it wishes to enter economic relations with other countries. Since the exchange rate represents the price of one currency in terms of another (Krugman/Obstfeld, 2006, p. 306), the choice of the regime has important implications for the conduct of international trade and investment. In order to provide a good environment for economic activity at the international level, numerous states decided to fix their exchange rate in the past. (Pilbeam, 1992, p. 252) An exchange rate is typically pegged through the obligation of monetary authorities to intervene in the

foreign exchange (FE)

market, that is by standing ready to buy or sell the domestic currency for FE or precious metals at a fixed parity.

Anja Zenker

2. Overview of Fixed Exchange Rate Regimes

In the modern era, the traditional dichotomy between fixed and floating exchange rates in international finance appears to be too simplified to cover the broad range of exchange rate regimes lying between and beyond these two extreme cases. By classifying exchange rate regimes according to their degree of fixity in their currency peg (Stocker, 2001, p. 54), three main categories can be distinguished, as shown in

Figure 1:

the use of a foreign currency as legal tender, fixed exchange rates, and flexible exchange rates (Gärtner/Lutz, 2009, p. 299f.). If a country is experiencing high inflation and is facing great difficulties in bringing it down due to a lack of credibility of its monetary authorities, it may decide to

unilaterally take over another currency for domestic payments


Anja Zenker

3. Theories of Currency Speculation in Fixed Exchange Rate Regimes

The experience with previous fixed exchange rate regimes has shown that such systems are quite prone to BOP crises. In fact, no fixed exchange rate regime has ever truly been fixed. (Mark, 2001, p. 256) Against the background of different currency crises, economists have developed diverse approaches to explain the causes and the timing of currency crises in fixed exchange rate systems. In general, we can distinguish three generations of models that all have emerged in response to the collapse of a pegging exchange rate regime: first-, second-, and third-generation models. In the following, we will discuss the S




model (1978), the first K


model (1979), and the F




model (1984) as FGMs. When dealing with SGMs, we refer to the O


model from 1994 and 1996 respectively. Finally, we examine the C






model (1999) as an example of the category of TGMs.

Anja Zenker

4. Empirical Evidence on Currency Crises in Fixed Exchange Rate Regimes

After considering the structure of currency speculation models and their findings, we will now address the empirical significance of the approaches. As these generations of models have been developed as a response to different currency crises in the past, we expect their explanatory power to vary across recent crisis experiences. More precisely, since FGMs have been developed to explain BOP crises experienced by developing countries during the 1970s and 1980s, they regard the collapse of a fixed exchange rate regime as the consequence of macroeconomic policies that are inconsistent with a pegged exchange rate. SGMs emerged after the 1992-93 EMS crises in which several exchange rate parities collapsed in spite of fiscal balances.

Anja Zenker

5. Policy Options

The strands of literature considered inherently offer different policy implications to avoid currency crises. While FGMs simply advise governments to ensure the consistency of internal and external targets to prevent speculative attacks from occurring, it is in practice harder to deal with the perceived authorities’ temptation to pursue domestic policy more expansionary than the exchange rate peg would allow. In this respect, SGMs suggest that the ability of governments to act on temptation can be effectively reduced by handing over the conduct of monetary policy to a conservative and independent central bank and by repeated affirmations of fiscal prudence and toughness in anti-inflation policy. They further recommend supply-side policies if the desired level of output is above the one associated with stable prices such as reforming the labor market, fostering investments in capital and infrastructure, and the acceptance of more realistic targets for output and employment.

Anja Zenker

6. Conclusions

Speculative currency crises seem to have become an inevitable and regularly occurring concomitant phenomenon of the international monetary system in which countries try to fix the price of their currency to other currencies or to a precious metal. In general, speculating agents tend to attack a currency if they believe the exchange rate commitment not to be credible in the face of different economic or political factors. Although fixed exchange rate regimes exhibit some favorable features concerning their impact on international trade and monetary discipline, they also give rise to certain risks such as the vulnerability of the domestic economy to foreign shocks or the permanent pressures of realignment. The liberalization of capital movements during the last decades has been further conducive to the increasing fragility of pegged exchange rate systems.

Anja Zenker


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