Prospective deficits and the Asian currency crisis

This paper argues that a principal cause of the 1997 Asian currency crisis was large prospective deficits associated with implicit bailout guarantees to failing banking systems. The expectation that these future deficits woul d be at least partially financed by seigniorage revenues or an inflation ta x on outstanding nominal debt led to a collapse of the fixed exchange rate regimes in Asia. We articulate this view using a simple model whose key fea ture is that a speculative attack is inevitable once the present value of f uture government deficits rises. We present empirical evidence in support o f the key assumptions underlying our interpretation of the crisis.