Fiscal Trends and Self-Fulfilling Crises

Antonio Doblas-Madrid ()

Review of International Economics, 2009, vol. 17, issue 1, pages 187-204

Abstract: This paper develops a second-generation currency crisis model with endogenously changing fundamentals. Previous second-generation models are static, e.g. Obstfeld (1994), or dynamic with exogenous paths of fundamentals, e.g. Obstfeld (1986). In our model, the government weighs the disutility of making fundamentals consistent with a peg against a penalty for floating. If the former dominates, the government runs expansionary policies, precipitating a crisis. For some parameters, self-fulfilling speculation affects when the crisis happens, but not whether it happens. For other values, there are "purely self-fulfilling" crises, where a peg that could have survived forever collapses if attacked in the first few periods. Copyright © 2009 The Author. Journal compilation © Blackwell Publishing Ltd 2009.

Date: 2009

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