Second Generation Currency Crisis Theory

The Second Generational Currency Crisis Theory

Introduction

Economic theory, specifically currency crises, has not changed much in the past few decades. While the theories that have become popular, such as the Mundell-Fleming Model and the Hecksher-Ohlin Model, are still valid today, new theories have been developed which are better suited for understanding and predicting currency crises in the 21st century. Most notably is the Second Generational Currency Crisis Theory developed in the early 2000s. This theory was developed by economist Barry Eichengreen and is considered to be one of the leading forerunners in modern currency crisis modeling.

Overview

The Second Generational Currency Crisis Theory is a model that tries to explain the underlying causes of currency crisis in the modern era. It looks at a number of factors that could lead to a currency crisis and then ensures an explanation based on the available data. This model goes beyond the traditional explanations by examining the political, legal and institutional frameworks that affect the stability of a currency. It also looks at the social, cultural and national level factors that shape the markets.

The main idea behind this model is that negative shocks, such as a devaluation of the exchange rate, can cause a crisis when coupled with certain pre-existing conditions. These pre-existing conditions include weak institutional frameworks, inadequate financial markets and inadequate regulation of financial institutions. This leads to an increase in the risk of a currency crisis occurring. The model also looks at the macroeconomic policy regime of the government and how it has had an impact upon the currency over time.

There is also an important factor in this model which is the role of contagion and the way that the markets can spread crisis from state to state. It looks at the effect of this contagion on the economic policy framework of different countries. It also examines how different shocks can lead to different effects depending on the framework of a particular country.

The Second Generational Currency Crisis Theory has been used to explain the various currency crises that have occurred in the past few decades. It has been used to explain the 1997 Asian crisis, the 2009 financial crisis and the 2019 Brexit crisis. It has also been used to explain the rise of the US dollar and the collapse of the Euro in the past few years.

Conclusion

The Second Generational Currency Crisis Theory is an important part of current economic theory and is one of the most important models used to explain currency crises in the modern era. This model looks deeply at the underlying conditions that can lead to a currency crisis and helps to explain why some states are more vulnerable to currency crises than others. This model is an important part of the currency crisis toolbox and will continue to be used in the future.

The Second Generation Currency Crisis Theory suggests that financial distress can result from the inability of a country to increase its supply of hard currency to pay its external debts. This type of crisis usually arises when a country has been unable to access international capital markets and, as a result, has been living beyond its means by running excessive deficits, leading to a mounting foreign debt. A currency crisis, in this context, typically manifests itself when default on the external debt becomes imminent.

In such a crisis, the countrys currency becomes weak and its prices become unreliable. The citizens of these countries, in order to create an alternative to the local currency, resort to other forms of money, such as gold, silver, or foreign currencies. This creates a demand for these alternative currencies, which causes an outflow of hard currency from the country as they are used to purchase these hard currencies.

The reduction in hard currency lowers the credit-worthiness of the domestic firms and makes foreign capital markets inaccessible, causing a further drain on the hard currency, a decrease in the local currencys value and a decrease in domestic prices. This effect can be observed in an increasing number of developing countries in recent years.

The Second Generation Currency Crisis Theory is an attempt to explain the phenomena that other theories, such as the Mundell-Fleming Model, have been unable to explain – namely, the phenomenon of a currency crisis resulting from a decrease in the supply of hard currency. Thus, this theory highlights the importance of governments and financial markets to consider the availability of hard currency as a way to prevent and manage financial crises.