News Release

August 27, 1998
Contact: Reuven Glick (415) 974-3184

How Do Currency Crises Spread?

Currency crises spread along the lines of international trade linkages, even after accounting for the effects of macroeconomic and financial factors, according to research results reported in the latest FRBSF Economic Letter, by Reuven Glick, Vice President and Director of the Center for Pacific Basin Monetary and Economic Studies at the San Francisco Fed, and Andrew K. Rose, visiting Fed scholar and Professor, Haas School of Business at the University of California, Berkeley.

The authors write: "Most economists tend to...emphasize macroeconomic fundamentals as determinants" in models of currency crises and focus on the ability or willingness of a central bank to defend its exchange rate peg. But since macroeconomic phenomena do not tend to be regional, these models do not explain why currency crises would be regional. Glick and Rose explore the regional spread of currency crises by focusing on trade patterns, because, they explain, "countries tend to export and import with countries in geographic proximity....[and] countries lose competitiveness when their trading partners devalue. They are therefore more likely to be attacked--and to devalue--themselves."

Glick and Rose examine data for five important currency crises--the 1971 breakdown of the Bretton Woods system, the 1973 collapse of the Smithsonian Agreement, the European Monetary System crisis of 1992-1993, the Mexican meltdown and "Tequila Hangover" of 1994-95, and the "Asia Flu" of 1997-98--to determine whether the "first victim" and subsequent targets were linked by international trade or whether they shared macroeconomic similarities. The authors also controlled for key aggregate and financial imbalances that might lead to a crisis.

The authors report that for all five crises, "countries that become 'infected'...have closer trade linkages to the 'first victim' than countries that escape the disease." For example, in the outbreak of the "Asian Flu" in 1997, "all of Thailand's top 10 trade competitors and 16 of its top 20 trade competitors were located in Asia.... Unsurprisingly, these countries were also disproportionately likely to have suffered speculative attacks."

"In contrast," they write, "none of the macroeconomic variables typically varies across crisis and non-crisis countries." Their research also indicates that "when macroeconomic and trade linkages are included simultaneously, the results are unchanged. The trade channel for contagion remains consistently important."

In summarizing their empirical evidence, Glick and Rose point out that "not all major trading partners devalued--indeed, not all were even attacked. Macroeconomic and financial influences were certainly not irrelevant. But neither was the trade channel irrelevant as a means of transmitting speculative pressures across international borders." The policy implications of these results are important, according to the authors: "If speculative attacks spread through trade links, then enhanced international monitoring on a regional basis is desirable. Moreover, if countries are more at risk to the spread of a currency crisis than is apparent by looking just at domestic economic factors, a lower threshold for international or regional assistance is also warranted in order to limit the spread of speculative attacks."