Spreading Currency Crises: The Role of Economic Interdependence

IMF Working Papers, August 1, 2002

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Spreading Currency Crises: The Role of Economic Interdependence

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Bibliographic details

• Authors: Wolfram Berger, Helmut Wagner
• Published: August 1, 2002
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451856453.001

Summary

• Authors: Wolfram Berger, Helmut Wagner
• Date: August 1, 2002
• Series: Working Paper No. 2002/144
• Pages: 20
• DOI: https://doi.org/10.5089/9781451856453.001
• Core claim: Mutual dependence of private sector expectations across countries affects the stability of fixed exchange rate regimes; increases in the perceived crisis probability of one country raise the devaluation probability of its trading partners.

Mechanism and Findings

• Interdependence channel:
  • Crisis probabilities of countries trading with one another are interdependent because wage setters react to an imminent loss of international competitiveness stemming from an increase in the crisis probability of a trading partner.
  • If a currency crisis in one country is perceived to be increasingly likely, the probability of devaluation of its trading partners’ currencies to restore their international competitiveness rises as well.
• Triggering factors:
  • Not only actual devaluations but also an increasing crisis probability may trigger currency crises elsewhere.
  • Both fundamental weaknesses and spontaneous shifts in market sentiment may play a role in precipitating currency crises.

Policy-relevant implications (derived from analysis)

• Monitor and account for cross-country expectation channels when assessing vulnerability of fixed exchange rate regimes.
• Recognize that perceptions and market sentiment can propagate crises even absent immediate fundamentals-based triggers.
• Wage-setting behavior and competitiveness concerns in trading partners are potential amplification mechanisms for crisis propagation.

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• Spreading Currency Crises: The Role of Economic Interdependence - WP/02/144
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