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Competitiveness, Realignment, and Speculation: The Role of Financial Markets

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  • Maurice Obstfeld

Abstract

Current and planned measures liberalizing the external capital accounts of France and Italy call into question the continued viability of the policy of periodic exchange-rate realignment followed to date in the European Monetary System (EMS). This paper is intended as a first step in studying the real and monetary effects of EMS-style realignments in a setting of free cross-border financial flows. The first set of results derived concerns a situation in which there are no fundamental factors behind domestic inflation. Under a policy regime in which domestic inflation automatically triggers devaluation, the economy can undergo self-fulfilling depreciation-inflation spirals, triggered by speculative attack on the exchange rate. Such spirals do not occur when realignments do not offset past inflation fully. The second set of results shows how an exchange rate collapse can occur after inflation is set off by expansionary fiscal policy. Sometimes, but not always, the crisis will be preceded by a period of capital inflows and real currency appreciation. In other cases fiscal expansion may set off an immediate crisis.

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File URL: http://www.nber.org/papers/w2539.pdf
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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2539.

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Date of creation: Mar 1988
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Publication status: published as The European Monetary System, edited by Francesco Giavazzi, Stefano Micossi , and Marcus Miller. New York: Cambridge University Press, 1988.
Handle: RePEc:nbr:nberwo:2539

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  1. Rogoff, Kenneth, 1985. "Can exchange rate predictability be achieved without monetary convergence? : Evidence from the EMS," European Economic Review, Elsevier, vol. 28(1-2), pages 93-115.
  2. Feenstra, Robert C, 1985. "Anticipated Devaluations, Currency Flight, and Direct Trade Controls in a Monetary Economy," American Economic Review, American Economic Association, vol. 75(3), pages 386-401, June.
  3. Robert P. Flood & Peter M. Garber, 1981. "A Model of Stochastic Process Switching," NBER Working Papers 0626, National Bureau of Economic Research, Inc.
  4. Obstfeld, Maurice, 1984. "Balance-of-Payments Crises and Devaluation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(2), pages 208-17, May.
  5. Francesco Giavazzi & Marco Pagano, 1991. "The Advantage of Tying One's Hands: EMS Discipline and Central Bank Credibility," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 303-330 National Bureau of Economic Research, Inc.
  6. Maurice Obstfeld, 1984. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc.
  7. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977 Elsevier.
  8. Blanco, Herminio & Garber, Peter M, 1986. "Recurrent Devaluation and Speculative Attacks on the Mexican Peso," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 148-66, February.
  9. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  10. Guillermo A. Calvo, 1983. "Staggered Contracts and Exchange Rate Policy," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 235-258 National Bureau of Economic Research, Inc.
  11. Corden, W Max, 1986. "Exchange Rate Depreciation, the Current Account and Wages," The Economic Record, The Economic Society of Australia, vol. 0(0), pages 14-21, Supplemen.
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Cited by:
  1. Pierre Villa, 1997. "Ces taux de change réels qui bifurquent," Working Papers 1997-05, CEPII research center.
  2. Garcia Rocabado, Daniel, 2010. "The road to monetary union in Latin America: An EMS-type fixed exchange rate system as an intermediate step," W.E.P. - Würzburg Economic Papers 85, University of Würzburg, Chair for Monetary Policy and International Economics.

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