The Logic of Currency Crises

Obstfeld, Maurice

The Logic of Currency Crises

No 4640, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Once one recognizes that governments borrow international reserves and exercise other policy options to defend fixed exchange rates during currency crises, the question arises: What factors determine a government's decision to abandon a currency peg or hang on? In a setting of purposeful action by the authorities, the possibility of self-fulfilling crises becomes important. Speculative anticipations depend on conjectured government responses, which depend, in turn, on how price changes that are themselves fueled by expectations affect the government's economic and political positions. The circular dynamic implies a potential for crises that need not have occurred, but that do because market participants expect them to. In contrast to this picture, most previous literature on balance-of- payments crises ignores the response of government behavior to markets. That literature, I argue, throws little light on events such as the European Exchange Rate Mechanism collapse of 1992-93. This paper then presents two different models in which crisis and realignment result from the interaction of rational private economic actors and a government that pursues well-defined policy goals. In both, arbitrary expectational shifts can turn a fairly credible exchange-rate peg into a fragile one.

JEL-codes: F31 (search for similar items in EconPapers)
Date: 1994-02
Note: IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (555)

Published as Cahiers economiques et monetaires, no. 43, pp. 189-213 (Paris: Banque de France, 1994).

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