The Economics of Currency Crises and Contagion: An Introduction

[...]We begin by discussing the so-called first generation ofmodels, in which crises are viewed in the literature as theunavoidable result of unsustainable policies or fundamentalimbalances. Next, we survey the literature on the secondgeneration of models, which highlights the possibility of selffulfillingexchange rate crises. We then turn to two key aspectsof recent crisis episodes that were not fully addressed inearlier models— namely, the role of the banking and financialsectors and the issue of “contagion,” which is thetransmission of a crisis across countries. We conclude byproposing a synthesis of the different views and applying it tothe Asia crisis. We contend that far from being mutuallyexclusive, contrasted approaches complement each other bypainting a comprehensive picture of the recent upheavals: thefundamental imbalances stressed by first-generation modelsmake a country vulnerable to shifts in investor sentiment;once a crisis does occur, the second-generation modelsexplain its self-reinforcing features.