Currency Flows and Currency Crises

According to the most common understanding, currency crises are always and everywhere a monetary phenomenon. Based on a formal theoretical model and ample empirical evidence, this article argues instead that currency crises are always and everywhere about external imbalances. They are usually preceded by booms in consumption, investment, and output. Since part of the added spending falls on imports, output and saving rise less than investment, pushing the current account into deficit. The exchange rate depends on the gap between cumulative capital inflows and the cumulative current account deficit. When the boom starts, this gap is positive and the central bank can hoard reserves and sterilize capital inflows. Yet later, as optimism fades, the gap inevitably turns negative, leading to the depletion of reserves and the collapse of the exchange rate. Panic can lead to precipitous speculative attacks. (JEL codes: F31, F32, F34, G01, G11.)