On the Fundamentals of Self-Fulfilling Speculative Attacks

Abstract

This paper proposes a theory of twin banking-currency crises in which both fundamentals arid self-fulfilling beliefs play crucial roles.Fundamentals determine whether crises will occur.Selffulfilling beliefs determine when they occur.The fundamental that causes 'twin crises' is government guarantees to domestic banks' foreign creditors.When these guarantees are in place twin crises inevitably occur, but their timing is a multiple equilibrium phenomenon that depends on agents' beliefs.So while self-fulfilling beliefs have an important role to play, twin crises do not happenjust anywhere.They happen in countries where there are fundamental problemsproblems such as guarantees to the financial sector.

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