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Currency Attacks with Multiple Equilibria and Imperfect Information: The Role of Wage-setters

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  • Femminis, Gianluca

Abstract

We consider a dynamic stochastic model of currency attacks, characterised by imperfect information about the fundamental. Agents, who imperfectly know the state of the economy, not only decide whether to attack the peg, but also formulate expectations concerning the probability of future devaluation. The subjective devaluation probabilities influence the inflation expectations, which, in their turn, affects the second period wage level and hence, unemployment. In this way, first period expectations affect the second period fundamental and hence the policymaker’s ability to resist to an attack. We show that equilibrium expectations may be either ‘optimistic’ or ‘pessimistic’. Optimistic (pessimistic) expectations involve a currency attack equilibrium characterised by a low (high) probability of devaluation. This result is due to the fact that agents decide upon next period wage having observed whether the current period currency attack has been successful or not. This publicly available information is sufficient to allow for a coordination effect among agents.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3291.

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Date of creation: Apr 2002
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Handle: RePEc:cpr:ceprdp:3291

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Keywords: asymmetric information; currency attacks; fixed exchange rate; global games; multiple equilibria;

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Cited by:
  1. Moheeput, Ashwin, 2008. "Financial Fragility, Systemic Risks and Informational Spillovers : Modelling Banking Contagion as State-Contingent Change in Cross-Bank Correlation," The Warwick Economics Research Paper Series (TWERPS) 853, University of Warwick, Department of Economics.

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