Academic journal article The European Journal of Comparative Economics

Twin Crises in Turkey: A Comparison of Currency Crisis Models

Academic journal article The European Journal of Comparative Economics

Twin Crises in Turkey: A Comparison of Currency Crisis Models

Article excerpt

1. Introduction

The twin crises in Turkey consist of a banking crisis in November 2000 and currency crisis that followed in February 2001.3 The crises were experienced due to a sudden increase in the demand for the dollar, which, in turn, caused the level of reserves to decrease swiftly. The Turkish government handled the crisis of November 2000, but it was not completely successful in handling the one in February 2001. So, the government had to abandon the fixed exchange rate regime and began to conduct a floating exchange rate regime. After this critical decision, the Turkish lira continued to devaluate against the US dollar. (4)

This paper analyzes these twin crises in Turkey. Following Akay (2004), we first perform a detailed literature survey on currency crisis models. After that, we create a brief descriptive overview of the crises in Turkey through which we attempt to find out the similarities between the twin crises in Turkey and the models that have been developed in order to explain preceding crises in the world. We hope that our detailed survey will serve as a reference for future research articles. Our main finding is that the Turkish twin crises cannot be explained by using any individual generation of models, namely first generation models (FGM), second generation models (SGM) or third generation models (TGM). Instead, a combination of these models is more appropriate to explain the details of the twin crises.

The Turkish twin crises are typical cases of crises known as currency crises or balance of payment crises. A currency crisis is an occurrence experienced in various economies all over the world. The crises that have been analyzed by the economists consist of the crisis in Latin America in the 1970s, the crisis in Europe in the early 1990s, and the crisis in Asia experienced in the late 1990s.

In general, currency crises are experienced when the government cannot fulfill its obligations (Calvo and Vegh, 1999). A typical case occurs in the case of a fixed exchange rate regime when the central bank cannot cover the increased demand for dollars coming from the individuals and institutions in the economy. As a result, the central bank is forced to let the exchange rate float. However, when we analyze the underlying reason for this scenario, we realize that this swift increase in demand is experienced because speculators, who foresee the devaluation of the currency, want to make a profit. This case is known as a speculative attack in the literature.

Most of the currency crises have been experienced in the countries in which governments are not seen as capable of continuing a fixed exchange rate regime. However, since all of the crises are experienced after speculative attacks, such governments have defended themselves, by accusing the speculators of such crises, and stating that the timing of the speculative attacks cannot be anticipated.

This timing problem has drawn the attention of economists toward speculative attacks. First, Krugman (1979) tried to explain the Latin American currency crises by introducing his model, which is accepted as the leader of FGM. FGM claims that the crises are a result of worsening economic fundamentals. After the crises experienced in the early 1990s, SGM have been developed, which not only take into account the worsening economic fundamentals, but, in addition to FGM, also focus on the expectations of the economy. After the 1997-1998 East Asian financial and currency crises, TGM were introduced, which are models of financial sector crises rather than of speculative attacks or currency crises per se. (5)

The rest of this paper is organized as follows: In Section 2, we introduce FGM. After that, we introduce SGM and TGM in Sections 3 and 4. The examination that shows whether the twin crises in Turkey, experienced in 2000 and 2001, can be explained by using any of these models is the subject of Sections 5 and 6. …

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