Currency Peg & Financial Crises Kristina Povilaityte 3 rd of May, 2012

Presentation Summary 1)Example of East Asia crisis )Example of Russia crisis )Durability of Fixed Exchange rates 4)Exiting pegging regimes 5)Adjustment under the peg

East Asia crisis Highly successful economic growth and foreign funding until the onset of the crisis Crises unanticipated Financial sector liberalization and reforms – uncompleted Financial systems became fragile Political mistakes accelerating panic

Decline in reserves due to peg Thai government maintain peg Huge spending from reserves Reserves below outstanding short term debts owed to international banks RESULT – more panic Only Indonesia floated on time but crisis continued due to other reasons

External conditions International market conditions were favorable BUT Decline in East Asian export due to:  Fall in the value of dollar for region's exports  Shift of export-oriented production to China  Competition from Mexico  Sharp real appreciation of USD Only a modest impact?

Russian crisis 1998 Peg to $ created background for the crisis Artificially high exchange rate Some other events also contributed to crisis Fiscal policy steps: 17 Aug - expanding trading band 2 Sept - de-pegging

Not fit to survive? Average duration of exchange rate regimes – 11 years only To be replaced by rigidly fixed rates or free floats?

Exiting pegging regimes Mostly forced de-pegging Some voluntary too – high crisis risks Earlier the better? Less harmful under favourable conditions

Adjustment under the peg Baltic states crisis Protecting peg through “internal devaluation”  Sizeable fiscal adjustment  Adjusting nominal wages  Preserving financial stability  Repairing private corporate & households balance sheets Denmark crisis – peg also defended

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