Imperfect common knowledge in first generation models of currency crises

Gara Minguez-Afonso

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: First generation models assume that the level of reserves of a Central Bank in a fixed exchange rate regime is common knowledge among consummers, and therefore the timing of the attack on the currency, in an economy with persistent deficit, can be correctly anticipated. In these models, the collapse of the peg leads to no discrete change in the exchange rate. We relax the assumption of perfect information and introduce uncertainty about the willingness of a Central Bank to defend the peg. In this new setting, there is a unique equilibrium at which the fixed exchange is abandoned. In our model, the lack of common knowledge will lead to a discrete devaluation of the local currency once the peg finally collapses.

JEL-codes: F31 G21 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2006-02-21
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:24509

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