ABSTRACT
Pervasive currency turmoil, particularly in Latin America in the late 1970s and early 1980s, gave impetus to a flourishing literature on balance-of-payments crises. As stressed in Paul Krugman’s (1979) seminal paper, in this literature crises occur because a country finances its fiscal deficit by printing money to the extent that excessive credit growth leads to the eventual collapse of the fixed exchange rate regime. With calmer currency markets in the mid-and late 1980s, interest in this literature languished. The collapse of the European Exchange Rate Mechanism, the Mexican peso crisis, and the wave of currency crises sweeping through Asia have, however, rekindled interest in the topic. Yet, the focus of this recent literature has shifted. While the earlier literature emphasized the inconsistency between fiscal and monetary policies and the exchange rate commitment, the new one stresses self-fulfilling expectations and herding behavior in international capital markets.1 In this view, as Guillermo A. Calvo (1995: 1) summarizes “If investors deem you unworthy, no funds will be forthcoming and, thus, unworthy you will be.”
