International Capital Flows, Currency Crises, and Exchange Rate Dynamics

Abstract

International capital flows—the movement of financial capital across national borders through foreign direct investment, portfolio equity and bond investment, bank lending, and official reserve accumulation—have grown dramatically since the dismantling of capital controls that began in the 1970s–1980s, creating both opportunities for risk sharing and sources of financial instability for recipient economies. Currency crises—episodes in which a fixed or managed exchange rate collapses, typically accompanied by reserve depletion and sharp economic contraction—have been recurrent features of emerging market financial development, from the Latin American debt crises of the 1980s through the Asian Financial Crisis (1997–1998), the Russian default (1998), the Argentine crisis (2001–2002), and the taper tantrum episodes of 2013 and 2022. This paper reviews the three generations of currency crisis models, Obstfeld and Rogoff’s (1996) international macroeconomics framework, the ‘original sin’ hypothesis for emerging market borrowing constraints, and the evolving policy toolkit for managing capital flow volatility including capital controls, macro-prudential measures, and international reserve accumulation.