Currency and Financial Crises in Emerging Market Economies in the Medium Run

Despite the success of third generation currency crisis models in describing the effects of currency shocks in countries with a large fraction of domestic liabilities denominated in foreign currency, these models lack some realism in the medium run. This is because they mostly disregard wage and price movements. Although these may not play an important role in the short-run, they become significant in the medium run and are therefore very relevant for the role of monetary policy during and after currency and financial crises. Based on previous work by Flaschel and Semmler (2003), we investigate empirically the effect of a sharp devaluation of the currency on aggregate investment and introduce a Phillips Curve in a basic financial crisis model to discuss both theoretically and empirically the emergence of asymmetries in medium run scenarios that might occur when wage and price dynamics are taken into account.