What triggers a drastic exchange rate depreciation? – Natixis

Analysts at Natixis look at two examples of large countries whose exchange rates have depreciated drastically: Argentina and Turkey. They explore the various possible explanations for this exchange rate collapse.

An abnormally expansionary monetary policy  

“An abnormally expansionary monetary policy relative to the level of inflation or the trade balance may lead to a drastic depreciation of the exchange rate. This explanation applies to Turkey (rate cuts in a situation of hyperinflation, sharply rising trade deficit), but not to Argentina.”

An abnormally expansionary fiscal policy 

“The exchange rate may also collapse if fiscal policy is abnormally expansionary and leads in particular to large external deficits. We see significant and rising fiscal deficits in Argentina and Turkey and a huge external deficit in Turkey only.”

A wage-price growth spiral

“If wages and prices spiral upwards, the resulting very high inflation ends up leading to a very sharp depreciation of the exchange rate. We see spiralling wage increases and inflation in both countries.”

A loss of confidence in the currency 

“A loss of confidence in the currency may stem from the previous factors (overly expansionary monetary or fiscal policy, spiralling inflation and wages). It leads to capital outflows that cause the exchange rate to plummet. We see net portfolio investment outflows only in Turkey.”