RDP 2002-08: Currency Crises and Macroeconomic Performance 4. Conclusion

This paper has reviewed international evidence on the effects of sudden nominal depreciations, and it has presented a framework for considering macroeconomic dynamics in the wake of a currency crisis. In many of the crises in our sample, output fell in response to a sudden depreciation, while the inflation response was mixed. Both the data and the formal modelling drew attention to the role of banking crises in these situations.

The model has several implications for policy. Formally, it showed that the optimal monetary policy response to a crisis depends upon the condition of the banking sector. Currency crises that cause, or coincide with, banking crises are different to those which are characterised by a simple opening of the international interest differential. Because twin crises are more likely to produce interest rate rises which overshadow the improved competitiveness that would normally flow from a depreciated exchange rate, they can produce declines in output.