The critical comparative review of theoretical models of exchange rate collapse

A currency crisis, frequently associated with economic crises, transpires when the national currency experiences a significant decline, resulting in an escalation of external debt and heightened risks of banking crises or default. This can engender devaluation, economic challenges, and political instability, particularly in diminutive nations with open economies. The primary objective of this article is to elucidate the causes and manifestations of currency crises through a comprehensive review of pertinent literature, identify their determinants, and address pertinent issues. The article underscores the imperative to comprehend the process that can engender inconsistencies in central bank actions and create an opportune environment for a speculative assault. This implies expanding the determinants of exchange rate crises beyond solely economic fundamentals by incorporating non-economic factors such as political incentives in the formulation of macroeconomic policy. The article focuses on the weak compatibility of the first- and second-generation models, and the lack of a model that would bridge the gap between traditional and non-traditional factors determining the currency crisis. The initial generation of models of the currency crisis, elucidated speculative attacks on fixed exchange rates attributed to government budget deficits. The second generation described multiple equilibria, suggesting self-fulfilling prophecies in which investors’ anticipations of government obligations impact currency stability.