ABSTRACT
With respect to exchange rate shocks due to currency runs triggering “nancial and real crises, there are three views, in fact three generations of models, that have been presented in the literature. A “rst view maintains that news on macroeconomic fundamentals (such as differences in economic growth rates, productivity differences and differences in price levels, in short-term interest rates as well as in monetary policy actions) may cause currency runs. The second view maintains that speculative forces drive exchange rates where there can be selfful“lling expectations at work, destabilizing exchange rates without deterioration of fundamentals. Third, following the theory of imperfect capital markets, it has recently been maintained that the dynamics of self-ful“lling expectations depend on some fundamentals, for example, the strength and weakness of the balance sheets of economic units such as households, “rms, banks and governments. From the latter point of view we can properly study the connection between the deterioration of fundamentals, exchange rate volatility, “nancial instability and declining economic activity. Although recently diverse micro-as well as macroeconomic theories have been proposed to explain currency runs, “nancial crises and recessions, we think that those types of models are particularly relevant that show how currency crises may entail destabilizing mechanisms leading, possibly through nonlinearities and multiple equilibria, to large output losses.
