Currency Crises and Monetary Policy: A Study on Advanced and Emerging Economies

Currency crisis literature offers a broad area of research regarding the causes and impacts of the phenomenon. The literature recently focuses on the appropriate policy measures in the aftermath of a currency crisis; however the studies do not gather around a robust answer regarding the appropriate monetary policy response in defending the domestic currency. This study tries to emphasize the notion that there is no single policy applicable for all currency crises happened and happening in the global world. The approach of the study is presenting empirical evidence by focusing separately on the advanced and emerging economies and proving that the monetary policy response for the emerging economies should be different from the advanced economies, depending mainly on the vulnerabilities of these economies preceding and during the crisis periods. The study includes twenty four economies, in which fifteen of them are emerging and nine of them are advanced, for the crisis periods between 1986 and 2009. The main finding of the study is that the tight monetary policy is effective in the advanced economies and detrimental in the emerging economies. Advanced economies besides having more independent central banking, lower country riskiness and almost no default history; mainly have second generation model weaknesses which cause the increased interest rates to be successful in stabilizing the exchange rates. For the emerging economies the third generation models play a major role together with the first generation models’ vulnerabilities. Thus the major policy implication follows that the policy makers should take into account the economic fragilities during the crisis in defending the currency.