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A Model of the ERM Crisis

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Author Info
F. Gulcin Ozkan
Alan Sutherland

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Abstract

Existing models of speculative attacks and balance of payments crises do not provide a good explanation for the breakdown of the ERM in 1992/93. This paper presents an alternative model which captures some of the important features of that period. The switch from a fixed to a floating rate regime is triggered, in this model, by an optimising government which wants to loosen monetary policy and boost aggregate demand. Agents in the foreign exchange market know the government's objective function and therefore build expectations of a regime switch into interest differentials. The resulting rise in interest rates affects the government's decision to switch regime (via the effect of interest rates on aggregate demand). It is shown that this interaction between private sector expectations and government preferences can imply a breakdown of the fixed rate sooner than the government would like.

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Publisher Info
Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 93-09.

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Handle: RePEc:kud:epruwp:93-09

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  1. Peter Kenen, 1996. "Analyzing and managing exchange-rate crises," Open Economies Review, Springer, vol. 7(1), pages 469-492, March. [Downloadable!] (restricted)
  2. Pastine, Ivan, 2001. "Speculation and the Decision to Abandon a Fixed Exchange Rate Regime," CEPR Discussion Papers 2893, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Torben Andersen, 1998. "Shocks and the Viability of a Fixed Exchange Rate Commitment," Open Economies Review, Springer, vol. 9(2), pages 139-156, April. [Downloadable!] (restricted)
  4. Barry Eichengreen, 2000. "The EMS Crisis in Retrospect," NBER Working Papers 8035, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Juan Garcia, 1999. "The Collapse of the ‘New EMS’: An Interpretation," Open Economies Review, Springer, vol. 10(2), pages 203-219, May. [Downloadable!] (restricted)
  6. W.H. Buiter, 1995. "Macroeconomic Policy During a Transition to Monetary Union," CEP Discussion Papers dp0261, Centre for Economic Performance, LSE. [Downloadable!]
  7. Weber, Axel A., 1997. "Sources of Currency Crisis: An Empirical Analysis," Discussion Paper Serie B 418, University of Bonn, Germany. [Downloadable!]
  8. Mundaca,B.G. & Strand,J., 1999. "Speculative attacks in the exchange market with a band policy : a sequential game analysis," Memorandum 01/1999, Oslo University, Department of Economics. [Downloadable!]
  9. Michael Bordo & Anna Schwartz, 1996. "Why clashes between internal and external stability goals end in currency crises, 1797–1994," Open Economies Review, Springer, vol. 7(1), pages 437-468, March. [Downloadable!] (restricted)
  10. Jenny Corbett & Gregor Irwin & David Vines, 1999. "From Asian Miracle to Asian Crisis: Why Vulnerability, Why Collapse?," RBA Annual Conference Volume, in: David Gruen & Luke Gower (ed.), Capital Flows and the International Financial System Reserve Bank of Australia. [Downloadable!]
  11. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Kruger, Mark & Osakwe, Patrick N. & Page, Jennifer, 1998. "Fundamentals, Contagion and Currency Crises: An Empirical Analysis," Working Papers 98-10, Bank of Canada. [Downloadable!]
  13. Michael D. Bordo & Anna J. Schwartz, 1997. "Why Clashes Between Internal and External Stability Goals End in Currency Crises, 1797-1994," NBER Working Papers 5710, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Axel A. Weber, 1998. "Sources of currency crises: an empirical analysis," Working Papers 25, Oesterreichische Nationalbank (Austrian Central Bank). [Downloadable!]
  15. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1994. "Speculative Attacks on Pegged Exchange Rates: An Empirical Exploration with Special Reference to the European Monetary System," NBER Working Papers 4898, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  16. Heinemann, Friedrich, 1998. "EMU and fiscal discipline : the end of the depreciation threat," ZEW Discussion Papers 98-30, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research. [Downloadable!]
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