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Explaining the Duration of Exchange-Rate Pegs

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  • Michael W. Klein
  • Nancy P. Marion

Abstract

This paper is a theoretical and empirical investigation into the duration of exchange-rate pegs. The theoretical model considers a policy-maker who must trade off the economic costs of real exchange- rate misalignment against the political cost of realignment. The optimal time to spend on a peg is derived and factors that influence peg duration are identified. The predictions of the model are tested using logit analysis with a data set of exchange-rate pegs for sixteen Latin American countries and Jamaica during the 1957-1991 period. We find that the real exchange rate is a significant determinant of the likelihood of a devaluation. Structural variables, such as the openness of the economy and its geographical trade concentration, also significantly affect the likelihood of a devaluation. Finally, political events that change the political cost of realignment, such as regular and irregular executive transfers, are empirically important determinants of the likelihood of a devaluation.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4651.

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Date of creation: Feb 1994
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Publication status: published as Journal of Development Economics, Vol. 54, no. 2 (December 1997): 387-404.
Handle: RePEc:nbr:nberwo:4651

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  1. Linda S. Goldberg, 1990. "Predicting Exchange Rate Crises: Mexico Revisited," NBER Working Papers 3320, National Bureau of Economic Research, Inc.
  2. Gilbert E. Metcalf, 2006. "Value-Added Tax," Discussion Papers Series, Department of Economics, Tufts University 0608, Department of Economics, Tufts University.
  3. Samuel Kortum, 1994. "A Model of Research, Patenting, and Productivity Growth," Boston University - Institute for Economic Development 37, Boston University, Institute for Economic Development.
  4. Wyplosz, Charles, 1986. "Capital controls and balance of payments crises," Journal of International Money and Finance, Elsevier, vol. 5(2), pages 167-179, June.
  5. Robert Flood & Nancy Marion, 1994. "The Size and Timing of Devaluations in Capital-Controlled Developing Countries," NBER Working Papers 4957, National Bureau of Economic Research, Inc.
  6. Rodrik, Dani, 1993. "Trade Liberalization in Disinflation," CEPR Discussion Papers 832, C.E.P.R. Discussion Papers.
  7. 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.
  8. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
  9. Heller, H Robert, 1978. "Determinants of Exchange Rate Practices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(3), pages 308-21, August.
  10. Holden, Paul & Holden, Merle & Suss, Esther C, 1979. "The Determinants of Exchange Rate Flexibility: An Empirical Investigation," The Review of Economics and Statistics, MIT Press, vol. 61(3), pages 327-33, August.
  11. 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.
  12. Heckman, James J. & Singer, Burton, 1984. "Econometric duration analysis," Journal of Econometrics, Elsevier, vol. 24(1-2), pages 63-132.
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