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A Centre-Periphery Model of Monetary Coordination and Exchange Rate Crises

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  • Buiter, Willem H
  • Corsetti, Giancarlo
  • Pesenti, Paolo

Abstract

The paper analyses the modalities and consequences of a breakdown of cooperation between the monetary authorities of inflation-prone periphery countries that use an exchange rate peg as an anti-inflationary device, when the centre is hit by an aggregate demand shock. Cooperation in the periphery is constrained to be symmetric: costs and benefits must be equal for all. Our model suggests that there are at least two ways in which a generalized crisis of the exchange rate system may emerge.The first is when the constrained cooperative response of the periphery is a moderate common devaluation while the non-cooperative equilibrium has large devaluations by a few countries. An exchange rate crisis emerges if periphery countries give in to their individual incentives to renege on the cooperative agreement. In the second case, the centre shock is not large enough to trigger a general devaluation in the constrained cooperative equilibrium; yet some of the periphery countries would devalue in the Nash equilibrium, making the monetary stance in the system more expansionary. In this case, reversion to Nash is collectively rational. We offer this model as a useful parable for interpreting the collapse of the ERM in 1992-3.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1201.

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Date of creation: Jul 1995
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Handle: RePEc:cpr:ceprdp:1201

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Keywords: Centre-Periphery; Exchange Rate Crises; Monetary Policy Coordination;

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References

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  1. Masson, Paul R, 1995. "Gaining and Losing ERM Credibility: The Case of the United Kingdom," Economic Journal, Royal Economic Society, vol. 105(430), pages 571-82, May.
  2. Gerlach, Stefan & Smets, Frank, 1995. "Contagious speculative attacks," European Journal of Political Economy, Elsevier, vol. 11(1), pages 45-63, March.
  3. Obstfeld, Maurice, 1996. "Destabilizing Effects of Exchange-Rate Escape Clauses," Department of Economics, Working Paper Series qt15n3p5dt, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  4. de Kock, Gabriel & Grilli, Vittorio, 1993. "Fiscal Policies and the Choice of Exchange Rate Regime," Economic Journal, Royal Economic Society, vol. 103(417), pages 347-58, March.
  5. Maurice Obstfeld, 1984. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc.
  6. Ozkan, F Gulcin & Sutherland, Alan, 1995. "Policy Measures to Avoid a Currency Crisis," Economic Journal, Royal Economic Society, vol. 105(429), pages 510-19, March.
  7. Persson, Torsten & Tabellini, Guido, 1995. "Double-Edged Incentives: Institutions and Policy Coordination," CEPR Discussion Papers 1141, C.E.P.R. Discussion Papers.
  8. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  9. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  10. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
  11. Ozkan, F. Gulcin & Sutherland, Alan, 1998. "A currency crisis model with an optimising policymaker," Journal of International Economics, Elsevier, vol. 44(2), pages 339-364, April.
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Citations

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Cited by:
  1. Weber, Axel A., 1997. "Sources of Currency Crisis: An Empirical Analysis," Discussion Paper Serie B 418, University of Bonn, Germany.
  2. Jesper Rangvid, 1997. "Deviations from long-run equilibria and probabilities of devaluations: An empirical analysis of Danish realignments," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 133(3), pages 497-522, September.
  3. Maurice Obstfeld, 1995. "Models of Currency Crises with Self-Fulfilling Features," NBER Working Papers 5285, National Bureau of Economic Research, Inc.
  4. Lodovico Pizzati, 2000. "Monetary Policy Coordination and the Level of National Debt," Empirica, Springer, vol. 27(4), pages 389-409, December.
  5. Olivier Jeanne, 1996. "Les modèles de crise de change : un essai de synthèse en relation avec la crise du franc de 1992-1993," Économie et Prévision, Programme National Persée, vol. 123(2), pages 147-162.
  6. Marion Kohler, 1999. "Coalition formation in international monetary policy games," Bank of England working papers 92, Bank of England.
  7. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, vol. 43(3-4), pages 263-286, November.
  8. W.H. Buiter, 1995. "Macroeconomic Policy During a Transition to Monetary Union," CEP Discussion Papers dp0261, Centre for Economic Performance, LSE.
  9. Lane, Philip R, 2000. " Asymmetric Shocks and Monetary Policy in a Currency Union," Scandinavian Journal of Economics, Wiley Blackwell, vol. 102(4), pages 585-604, December.
  10. Chantal Dupasquier & Patrick N. Osakwe & Shandre M. Thangavelu, 2005. "Choice of Monetary and Exchange Regimes in ECOWAS : An Optimum Currency Area Analysis," Macroeconomics Working Papers 22570, East Asian Bureau of Economic Research.
  11. Balogun, Emmanuel Dele, 2008. "An alternative reconsideration of macroeconomic convergence criteria for West African Monetary Zone," MPRA Paper 11367, University Library of Munich, Germany.
  12. Marion Kohler, 1998. "Optimal currency areas and customs unions: are they connected?," Bank of England working papers 89, Bank of England.
  13. Chantal Dupasquier & Patrick N. Osakwe & Shandre M. Thangavelu, 2005. "Choice of Monetary and Exchange Regimes in ECOWAS: An Optimum Currency Area Analysis," SCAPE Policy Research Working Paper Series 0510, National University of Singapore, Department of Economics, SCAPE.
  14. Thomson Fontaine, 2005. "Currency Crises in Developed and Emerging Market Economies," IMF Working Papers 05/13, International Monetary Fund.
  15. Balogun, Emmanuel Dele, 2008. "An Empirical Test of Trade Gravity Model Criteria for the West African Monetary Zone (WAMZ)," MPRA Paper 7083, University Library of Munich, Germany.
  16. Axel A. Weber, 1998. "Sources of Currency Crises: An Empirical Analysis," Working Papers 25, Oesterreichische Nationalbank (Austrian Central Bank).
  17. Lane, Philip R., 1996. "Stabilization policy in a currency union," Economics Letters, Elsevier, vol. 53(1), pages 53-60, October.
  18. Balogun, Emmanuel Dele, 2009. "Alternative reconsideration of output growth differrential for the West African Monetary Zone," MPRA Paper 13416, University Library of Munich, Germany.

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