Twin crises

[6][7][8] To address this ambiguity in the theory, Kaminsky and Reinhart (1999)[1] conducted an extensive empirical work for 20 countries over a 25-year sample and found that banking-sector problems not only are generally followed by a currency crisis, but also help to predict them.

That is, the goal was to create signals that, by surpassing some threshold, would alarm policymakers about upcoming crises, in order to prevent them from happening (or at least to diminish their effects) by making use of adequate economic policy.

During the last three decades of the 20th century, developing and emerging market countries suffered both banking and currency crises more often than advanced economies.

The openness of emerging markets to international capital flows, along with a liberalized financial structure, made them more vulnerable to twin crises.

Those economies were in fact experiencing a period of "Great Moderation", a term coined by Stock and Watson (2002)[12] in reference to the reduction of the volatility of business cycle fluctuations, which could be seen in the data since the 1980s.

Robert Lucas Jr., 1995 Nobel Memorial Prize in Economic Sciences winner, for example said that the "central problem of depression-prevention (has) been solved, for all practical purposes".

As Reinhart and Rogoff (2008)[14] showed later, this idea was myopic because those countries only took into consideration a very short and recent sample of crises; all the research was being made with data starting on the 1970s.

Emerging markets showed a much faster recovery from the crisis, while several advanced economies faced deep and long recessions.

This did not allow them to devalue their currency to dampen the impact of negative shocks and restore balance to the current account, which ultimately contributed to the European sovereign-debt crisis.