First-generation, Second-generation and Third-generation of Currency Essay

First-generation, Second-generation and Third-generation of Currency Crises Models - Essay Example Currency crisis can originate from a financial crisis associated with an actual economic crisis that can cause depletion of valuable reserves. The drastic effects of a changing value of currency can be very brutal to small economies as compared to relatively larger ones. The government or major bodies of authorities should regulate and defend the currency by fulfilling the surplus demand for a given currency using the currency reserves of the country or by using its foreign reserves or by elevating the interest rates. Throughout history we have seen a large number of currency crisis that have affected many economies worldwide leading to recessions like the economic crisis in Mexico in 1994, the Asian crisis in 1997, the case of the Hong Kong dollar in 1998 and Russian crisis in 1998. The rapid increase in the number of currency crises after the Latin American debt crisis in the 1980s was alarming. This resulted in extensive research and in the conception of many theories and models. Thus, the first methodical formation of currency crisis model came in 1979 by Paul Krugman in his extensive research based on Steve Salant and Dale Henderson’s paper published in 1978. This model was based on the study of how efficiently the trade prices of articles of trade could stabilize after concerned authorities had an insight that an investor will hold on to an exhaustible resource if he expects its price to rise quick enough offering him a profitable return rate. This concept is based on Hotelling lemma’s exhaustible resource pricing leading to a choking point when the price has risen to such a height that ultimately there isn’t any more demand left. The... This essay declares that a currency crisis is a catastrophe that takes place when a tentative attack on the exchange value of a currency leads to the devaluation or unexpected depreciation in a country’s currency value. A currency crisis can also lead to a balance-of-payments crisis or a huge exchange rate depreciation or even a massive international reserve loss, or all of the above. Most economists agree that a speculative hit in the foreign exchange market usually affects fixed exchange rate markets rather than floating exchange rate markets. Currency crisis can originate from a financial crisis associated with an actual economic crisis that can cause depletion of valuable reserves. The drastic effects of a changing value of currency can be very brutal to small economies as compared to relatively larger ones. The government or major bodies of authorities should regulate and defend the currency by fulfilling the surplus demand for a given currency using the currency reserves of the country or by using its foreign reserves or by elevating the interest rates. This paper makes a conclusion that the growing trend in the shadow price was provided by supposing that the government issues money to finance the country’s budget deficits, however the central bank is prepared to defend the exchange rate through international reserves. Hence, Salant further worked on a gold price stabilization technique.