Set out the signals that a currency crisis may be coming
The idea
Currency crises tend to follow recognisable build-ups, though timing is hard to call. Warning signs include a real exchange rate well above its historical average, falling reserves, deteriorating terms of trade, rapid domestic credit growth often after financial liberalisation, large capital inflows that start to reverse, inflation high relative to trading partners, broad money growing fast relative to reserves, weakening output and banking stress. Contagion from crises in similar economies can trigger an attack even when fundamentals are only moderately weak. Crises can hit countries whose current account and fiscal positions look comfortable, so relying on one or two headline measures is the trap. Early-warning systems combine many signals and accept false alarms.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Currency Exchange Rates: Understanding Equilibrium Value
- For a spot or forward currency quote, work out and explain its bid–offer spread and say what makes that spread wider or narrower
- Given bid–offer quotes for three currencies, spot a triangular arbitrage and work out the profit it yields
- Explain spot and forward exchange rates and work out a currency's forward premium or discount
- Work out a forward contract's value when marked to market
- Explain the international parity conditions, namely interest rate parity in its covered and uncovered forms, the international Fisher effect, purchasing power parity and forward rate parity
- Set out how the international parity conditions link to one another
- Judge how well today's spot rate, the forward rate, uncovered interest parity and purchasing power parity each forecast future spot rates
- Explain the ways of estimating what an exchange rate is fairly worth over the long run
- Explain the carry trade and its link with uncovered interest rate parity, and work out what it earns
- Explain how the flows recorded in the balance of payments move exchange rates
- Explain what fiscal and monetary policy may do to exchange rates
- Set out why central banks or governments intervene in currency markets or impose capital controls, and how well such measures work