The Persistence of Unemployment Under a Fixed Exchange Rate Peg

Olivier Jeanne

No C97-093, Center for International and Development Economics Research (CIDER) Working Papers from University of California at Berkeley

Abstract: This paper studies the dynamics of unemployment under a fixed exchange rate peg with an escape clause. The interesting aspects of these dynamics come from the interaction between unemployment and the devaluation expectations. While an increase in the unemployment rate raises the devaluation expectations, reciprocally the latter influence the unemployment rate through the level of interest rates. We present a model in which this interaction tends to increase the level and the persistence of unemployment, and can even generate some hysteresis in the unemployment dynamics that is associated with a currency crisis. The estimation of the model in the case of the French franc sheds new light on the franc crisis of 1992-93, as well as the franc fort policy and the convergence criteria of the Maastricht Treaty.

Date: 1997-07-01
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