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would be characterized by a gradual but persistent decline in international reserves and a rapid growth of domestic credit relative to the demand for money. Also, to the extent that excessive money creation may result from the need to finance the public sector, fiscal imbalances and credit to the public sector also could serve as indicators of a looming crisis.

A number of papers have extended Krugman's basic model in various directions.<sup>3</sup> Some of these extensions have shown that speculative attacks would generally be preceded by a real appreciation of the currency and a deterioration of the trade balance. These results have been derived from models in which expansionary fiscal and credit policies lead to higher demand for traded goods (which causes a deterioration of the trade balance) and nontraded goods (which causes an increase in the relative price of these goods, and thus a real appreciation of the currency). They also follow from models in which expectations of a future crisis lead to an increase in nominal wages which, in the presence of sticky prices, results in higher real wages and lower competitiveness. Also, models that introduce uncertainty about credit policy or about the level of reserves losses that the authorities are willing to sustain to defend the parity, show that domestic interest rates would increase as a crisis becomes more likely. Thus, these models suggest that the evolution of the real exchange rate, the trade or current account balance, real wages, and domestic interest rates, could be used as leading indicators of crises.

# **B. Recent Models**

While the traditional approach stresses the role played by declining international reserves in triggering the collapse of a fixed exchange rate, some recent models have suggested that the decision to abandon the parity may stem from the authorities' concern about the evolution of other key economic variables-suggesting that yet another family of variables could be useful in helping predict currency crises.

For instance, Ozkan and Sutherland (1995) present a model in which the authorities' objective function depends positively on certain benefits derived from keeping a fixed nominal exchange rate (such as enhanced credibility in their efforts to reduce inflation) and negatively on the deviations of output from a certain target level. Under a fixed exchange rate, increases in foreign interest rates lead to higher domestic interest rates and lower levels of output, making it more costly for the authorities to maintain the parity. Once foreign interest rates exceed some critical level, the cost of keeping the exchange rate fixed surpasses the benefits, and the authorities abandon the parity. Based on this model, therefore, the evolution of output and domestic and foreign interest rates may be useful as indicators of currency crises.

More generally, this approach suggests that a variety of factors which may affect the authorities' objective function could be used as leading indicators of currency crises. For instance, an increase in domestic interest rates needed to maintain a fixed exchange rate may 3References to these papers can be found in the surveys mentioned above. In addition to those described in the main text, the extensions include post-collapse exchange systems other than a permanent float (such as fixed, crawling, and transitory float), the possibility of foreign borrowing, capital controls, imperfect asset substitutability, and speculative attacks in which the domestic currency is under buying rather than selling pressure.