It is shown by original currency crisis model that mistakes in monetary and fiscal policy were at the root of the Russian financial crisis of 1998. A combination of high interest rates with high sensitivity of inflation rate to the rate of currency depreciation, low duration of debt and low GDP monetization generated exchange rate appreciation and rapid domestic-currency debt accumulation. When the debt became too high to service, investors started to flee. Protective interest rate hike by the monetary authorities was counterproductive, accelerating the approach of the crisis via the growth in the debt-servicing payments and GDP contraction. The budget restriction of 3% of GDP, used in EC countries, was too loose for Russia in the pre-crisis period.