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We then analyzed the current account approach; that is, the view that large current account deficits may be unsustainable and lead to balance of payments crises. While this channel could provide a concrete link between the dynamics of exchange rate-based stabilizations and their demise, it still has precious little to say outside the steady-state. In addition, the mechanics through which a BOP crisis would occur are unclear. Finally, we highlighted the role of financial considerations and credibility as contributing factors in unleashing balance of payments crises.

Under high information costs and globalization, demand for emerging markets’ assets is likely to be highly sensitive to rumors and relatively unresponsive to fundamentals. Changes in investors’ sentiments could make it difficult for the government to roll-over a large stock of shortterm debt, leading to a bond-led attack. A large stock of short-term debt may also result in self-fulfilling crises. Lack of credibility in the peg — and thus high nominal interest rates — may also put into motion Krugman-type machinery in the face of a large stock of domestic debt. in detail

Where do we go from here? In the area of inflation stabilization, much empirical work remains to be done on the empirical regularities of disinflation in chronic inflation countries. Numerous problems need to be addressed, including sample selection and small samples for money-based programs. Small samples for successful exchange rate-based programs also pose a problem since the econometric finding of a late recession is clearly influenced by events in failed programs.

A critical aspect in econometric work is to control for other domestic factors, such as trade and structural reforms. Disentangling the effects of stabilization from other reforms is important not only to make sure that the empirical regularities remain such, but also because we may be asking theoretical models to explain ’’too much”, quantitatively speaking. It would also be important to document in a systematic way the behavior of the home goods-sector relative to the traded-goods sector. Some available evidence suggests that the initial boom is much more evident in the home-goods sector. The behavior of investment should also be looked at in more detail. The goal of this research agenda would be to establish how much needs to be explained and then build more refined quantitative models to evaluate the alternative hypotheses, along the lines of Rebelo and Vegh (1995).

It is clear that we are still far away from a good understanding of the links between the dynamics of exchange rate-based stabilizations and their ultimate demise. While Krugman’s (1979) model and variations thereof provide a good description of the mechanics of BOP crises, they offer in general little insights into the more fundamental causes of such crises — over and above the obvious implication that a deterioration in the fiscal balance during a program will put into motion Krugman-type dynamics. We feel that the notion of current account sustainability needs substantial refinement before it can offer a consistent and complete account of the facts, but is an area definitely worth pursuing.

In this respect, a productive area of research would be to focus on the role of the financial and banking sectors in amplifying the expansionary cycle and possibly contributing to the downturn and eventual crisis. A particularly relevant channel has to do with the real estate market. A sizeable fraction of the lending boom goes to finance real estate operations (see, for instance, Guerra (1997a)). These loans are usually made using as collateral temporarily-high asset prices. In the context of the temporariness hypothesis, Guerra (1997b) shows an example in which the fall in asset prices (i.e., land prices) before the abandonment of the program may trigger a banking crisis. While this does not explain the end of the program, it does provide a link between the dynamics of these programs and banking crises.