Structural Vulnerability and Resilience to Currency Crisis

What is it about?

Exports are an important factor to prevent currency crises that has not been analyzed in the theoretical literature. Using the third generation model of currency crises, I derive a simple and intuitive formula that captures an economy’s structural vulnerability characterized by the elasticity of exports and repayments for foreign currency denominated debt. I graphically show that the possibility of currency crisis equilibrium depends on this structural vulnerability and also analyze how this vulnerability impacts the effectiveness of monetary policy response.

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Why is it important?

The introduction of exports into the model suggests that depreciation of the exchange rate has both positive and negative effects on the real economy because it increases exports, on the one hand, but reduces retained earnings via increased debt repayments of the foreign debt, on the other hand. In this manner, the tradeoff between exports and foreign currency denominated debt can be analyzed under the circumstance of exchange rate depreciation in my model. Graphical explanations are provided to see this tradeoff. I found that the size of the export sector to foreign currency debt and the exchange rate elasticity of exports determine the resilience to currency crises.

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