Give an example of an exchange rate crisis that has occurred in the past, the reasons why
the crisis occurred and how such a self-fulfilling prophecy comes into play during this
crisis. Some examples of exchange crises are the 1994 Mexican Peso Crisis, 1998
exchange rate crisis in Argentina, 1997 Asian crisis, 2000-2001 exchange rate crisis in
Turkey, etc. Each example given in class should be unique.
Implementing the new currency, the Real, in 1994 Brazil faced inflation rates of over
900%. Brazil immediately implemented the Real Plan and took steps to control the large
federal deficits, restrained monetary policies, and pegged against the US dollar sending a
signal to the world that they were taking steps to control their inflation. Despite their
attempts to control inflation through controlled devaluation, the inflationary rates of the
Real against the inflationary rates of the USD were too vastly different to offset. This
variance made it difficult for Brazilians to sell their products aboard while simultaneously
encouraging the Brazilians to purchase abroad.
The Real was overvalued and investors began to eliminate their investments in Brazil. To
encourage the investors to remain, Brazil raised interest rates. This increase made investors
nervous, particularly following the Asian financial crisis of 1997 and the Russian financial
crisis of 1998 and investors continued to leave.
Despite concerns over the Real, their GDP ratio did not reflect a crisis. However, after
inflationary increases, the deficit in Brazil continued to rise, making investors even warier.
Investors who still dared to invest in Brazil opted for short term investments and Brazil’s
short-term to total debt increase substantially.
As these issues compounded, calls were made for devaluation of the Real. Newly elected
president Fernando Cardoso had one last attempt to try to save his country from
devaluation. He announced a new budget plan that would save about $23 billion. Despite
his attempts, things continued to look bleak and capital outflows accelerated quickly.
Despite years of attempts to stabilize its new currency, Brazil announced in January 1999
they would stop pegging and allow the currency to be devaluated.
How do you assess exchange rate uncertainty using historical data? Give examples in your
answer. No, two examples given in class should be the same.
In order to understand transaction exchange risk, it’s important to understand the historical
volatility. The wider the distribution between future exchange rates, the higher the risk.
The width of distribution is dependent on the volatility/standard deviation of changes in
