Currency Crisis and Stabilization Programme: A Third Generation Approach

A central accompanying feature of financial market liberalization under fully convertible currency was unusual number of severe financial crisis. However, the recent episode of East Asian crisis is considered to be distinctive in several respects. First, it appears to be the first genuinely global financial crisis to hit emerging market economies. Secondly, the Asian crisis appears to be more deeply rooted in financial imbalances in private sector than in the public sector financial problems that characterized the 1980s debt crisis and the Mexican 1994-95 crisis. Thirdly, the crisis involves increasingly dramatic effects. Measured in terms of bank and firm defaults, the costs are enormous. Measured in terms of output and employment loss, the costs are even more frightening. These features of Asian crisis make the third generation approach a relevant framework of analysis. This paper takes credit view of currency crisis as point of departure. In section I we have examined emergence of currency crisis due to rise in risk premium and focused on the macroeconomic adjustment in response to fiscal policy and monetary policy in a hyperdepreciation-led situation of currency crisis under static expectation. We have introduced rational expectation regarding expected depreciation in section II. We have attempted a rational expectation formalization of Krugman’s model (2003) so as to focus on comparative static implications of monetary and fiscal policies in the post-crisis situation.