Third Generation Crisis

Third Generation Crisis

First and second generation models were able to explain some currency crises. However, since Latin America and 1997 South East Asian crises could not be explained in second generation models so third models were formed.

The third-generation models were discriminated from the first and second-generation models by not just explaining the currency crisis. Since both currency and financial crises are both a combination, they are called twin-crisis models . (Berlemann et al., 2002, 12).

The crisis that started in Thailand in 1997 and spread to other Asian countries is considered in the 3rd model. Basically, Latin America and 1997 South East Asia aimed to explain the crisis.

The other name of this model is called as contagion models.

At the beginning of 1997, the governments of the countries that had a crisis were in very good condition. Most of the crisis has confounded most observers. Interestingly, shortly before the crisis, even the IMF predicted growth that could be considered quite optimistic. Even after the crisis, there was no indication that these countries were at risk of crisis or were at risk of extraordinary risk during the crisis. This uncertainty has led researchers to develop new models. Whatever the cause of the currency crisis, both the first-generation and second-generation crisis models did not pay any attention to the interaction of money and banking crises (Kaminsky and Reinhart, 1998, p.1).

This model is based on Krugman's(1998) ‘Government's Moral Risk Approach ’and Sach's(1998 and 1998) ‘Financial Attack Approach’ theses. The third model acts by considering that the crises of currency affect the other sector and the crises that start in a sector create circulation in this case. (Durmuş, 2010:8).

In these models, the financial crisis is linked to the financial sector and it is argued that the crises are mainly caused by the banking system. (Danışoğlu, 2007:5).
In other words, relations between the government and large-scale enterprises cause crisis. Moreover the crises are defined as contagious crises related to the speculative pressure of one country might trigger other countries crisis probability. The first two generations are prescribed for the crisis of crisis in the crisis models, increasing interest rates and increasing the demand for domestic money. However, an increase in interest rates in the third generation crisis models affects the amount of credit and limits the firms' access to investment capital.

The failure of the government to guarantee the obligations of banks in the work of Krugman causes the moral risk problem. While East Asian financial institutions lend to companies, they have misrepresented the government's reimbursement guarantee and gave false credit. These firms could not take risks and take full risk assessment. Therefore, they preferred to invest only in areas with high expected profits.

Since the false credit distribution was made, the future risks could not be foreseen and the real asset prices were over-elevated and it was observed that the investment was disproportionate due to the repetition of the investment in the same area. The investment boom in certain areas (such as the real estate market) can be sustained as long as the government's repayment guarantee is valid, and the loss of the validity of the said guarantee also reduces the price of the real asset and leads to a monetary crisis.