Rational and Self-Fulfilling Balance-of-Payments Crises

Maurice Obstfeld

No 1486, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The recent balance-of-payments literature shows that-speculative attacks on a pegged exchange rate must sometimes-occur if the path of the rate is riot to offer abnormal profit opportunities. Such attacks are fully rational, as they reflect the market's response to a regime breakdown that is inevitable.This paper shows that, given certain expectations about policy, balance-of-payments crises can also be purely self-fulfilling events. In such cases even a permanently viable regime maybreak down, and the economy will possess multiple equilibria corresponding to different subjective assessments of the probability of collapse. The behavior of domestic interest rates and foreign reserves will naturally reflect the possibility of a speculative attack. Work on foreign-exchange crises derives from the natural-resource literature initiated by Salant and Henderson (1978),where the definition of "abnormal" profit opportunities is straightforward. Because the definition is not always straight-forward in a monetary context, this paper also shows how crises occur in a discrete-time stochastic monetary model when an eventual breakdown is inevitable.

Date: 1984-11
Note: ITI IFM
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Published as Obstfeld, Maurice. "Rational and Self-Fulfilling Balance-of-Payments Crises ." American Economic Review, Vol. 76, No. 1, (March 1986), pp. 72-81.

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Journal Article: Rational and Self-fulfilling Balance-of-Payments Crises (1986)
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