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Interest Rates, Terms of Trade, and Currency Crises: Are We on the Verge of a New Crisis in the Periphery?

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Financial Deepening and Post-Crisis Development in Emerging Markets

Abstract

In this chapter we develop a simple model of currency crises, which emphasizes the role of currency mismatches and the balance of payments constraint. In our model, crises are driven by external shocks, particularly foreign interest rate and terms of trade shocks, which drive payments imbalances. In a reversal of conventional causality, we show how a currency crisis can then produce a domestic fiscal crisis. We then discuss the historical relevance of the model, tracing the major waves of currency and fiscal crises. The chapter concludes with an assessment of the current situation of the peripheral countries in light of our model and argues that concerns of a renewed wave of currency crises may be overstated.

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Author information

Authors and Affiliations

  1. Assistant Professor of Economics, University of Redlands, Redlands, CA, USA

    Nathaniel Cline

  2. Professor of Economics, Bucknell University, Lewisburg, PA, USA

    Matías Vernengo

Authors
  1. Nathaniel Cline
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  2. Matías Vernengo
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Editor information

Editors and Affiliations

  1. St. John's University, Queens, New York, USA

    Aleksandr V. Gevorkyan

  2. World Bank, Potomac, Maryland, USA

    Otaviano Canuto

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Cline, N., Vernengo, M. (2016). Interest Rates, Terms of Trade, and Currency Crises: Are We on the Verge of a New Crisis in the Periphery?. In: Gevorkyan, A., Canuto, O. (eds) Financial Deepening and Post-Crisis Development in Emerging Markets. Palgrave Macmillan, New York. https://doi.org/10.1057/978-1-137-52246-7_3

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