A Center-Periphery Model of Monetary Coordination and Exchange Rate Crises

Willem Buiter, Giancarlo Corsetti and Paolo Pesenti

No 5140, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The paper analyzes the modalities and consequences of a breakdown of cooperation between the monetary authorities of inflation-prone Periphery Countries that use an exchange rate peg as an anti- inflationary device, when the Center is hit by an aggregate demand shock. Cooperation in the Periphery is constrained to be symmetric: costs and benefits must be equal for all. Our model suggests that there are at least two ways in which a generalized crisis of the exchange rate system may emerge. The first is when the constrained cooperative response of the Periphery is a moderate common devaluation while the non-cooperative equilibrium has large devaluations by a few countries. An exchange rate crisis emerges if Periphery countries give in to their individual incentives to renege on the cooperative agreement. In the second case, the Center shock is not large enough to trigger a general devaluation in the constrained cooperative equilibrium; yet some of the Periphery countries would devalue in the Nash equilibrium, making the monetary stance in the system more expansionary. In this case, reversion to Nash is collectively rational. We offer this model as a useful parable for interpreting the collapse of the EMR in 1992-93.

JEL-codes: F31 F33 (search for similar items in EconPapers)
Date: 1995-06
Note: IFM ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Published as Financial Markets and European Monetary Cooperation: The Lessons of the 92-93 ERM Crisis, Cambridge University Press, 1998.

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Working Paper: A Center-Periphery Model of Monetary Coordination and Exchange Rate Crises (1995)
Working Paper: A Centre-Periphery Model of Monetary Coordination and Exchange Rate Crises (1995)
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