The wave of financial globalization during the early and mid-1990s was accompanied by crises that demonstrated the volatility of capital flows. This chapter describes the European currency crisis of 1992–3 and the Mexican crisis of 1994–5. These events revealed that capital inflows could be quickly reversed and pose a threat to financial stability by undermining exchange rate commitments.

The background and outbreak of the European crisis are presented in the first section. European governments had formed a fixed exchange rate pact in the 1980s as part of a move toward deeper economic integration within the EC and strengthened their ties in the 1990s. But increases in German interest rates put pressure on the exchange rate pegs and demonstrated how fixed rates and unregulated capital could constrain national policies. Most of the governments subsequently proceeded with the introduction of the euro, although the United Kingdom withdrew from the arrangement.