Theories of Currency and Banking Crises: A Literature Review

Abstract

Currency and banking crises in Latin America, Europe, and Asia over the past three decades have generated substantial literature on their causes. The literature on currency crises begins with models developed to explain crises experienced by some Latin American countries in the late 1970s. These models view currency crises as being caused by weak economic fundamentals. Following the collapse of the European Monetary System in 1992, the so-called second-generation models of currency crises emerged. These models show that currency crises can occur due to certain government policy actions, self-fulfilling expectations of market participants, and possibilities of multiple equilibriums, even in the absence of fundamental weaknesses. The theoretical currency crisis literature has expanded further since the 1997 Asian financial crisis. The so-called third-generation models view a currency crisis as a run on an economy or a financial panic.