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

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  • Willem H. Buiter
  • Giancarlo Corsetti
  • Paolo A. Pesenti

Abstract

The paper analyzes 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 Center 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 Center 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 EMR in 1992-93.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5140.

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Date of creation: Jun 1995
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Publication status: published as Financial Markets and European Monetary Cooperation: The Lessons of the 92-93 ERM Crisis, Cambridge University Press, 1998.
Handle: RePEc:nbr:nberwo:5140

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  1. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  2. 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.
  3. Gulcin Ozkan & Alan Sutherland, . "A Currency Crisis Model with an Optimising Policymaker," Discussion Papers 96/11, Department of Economics, University of York.
  4. Obstfeld, Maurice, 1991. "Destabilizing Effects of Exchange-Rate Escape Clauses," CEPR Discussion Papers 518, C.E.P.R. Discussion Papers.
  5. 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.
  6. Persson, Torsten & Tabellini, Guido, 1995. "Double-edged incentives: Institutions and policy coordination," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 38, pages 1973-2030 Elsevier.
  7. Stefan Gerlach & Frank Smets, 1994. "Contagious speculative attacks," BIS Working Papers 22, Bank for International Settlements.
  8. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
  9. Maurice Obstfeld, 1984. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc.
  10. 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.
  11. 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.
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Cited by:
  1. Axel A. Weber, 1998. "Sources of Currency Crises: An Empirical Analysis," Working Papers 25, Oesterreichische Nationalbank (Austrian Central Bank).
  2. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, vol. 40(3-5), pages 1037-1047, April.
  3. Buiter, Willem H, 1995. "Macroeconomic Policy During a Transition to Monetary Union," CEPR Discussion Papers 1222, C.E.P.R. Discussion Papers.
  4. Thomson Fontaine, 2005. "Currency Crises in Developed and Emerging Market Economies," IMF Working Papers 05/13, International Monetary Fund.
  5. Lane, P, 1999. "Asymmetric Shocks and Monetary Policy in a Currency Union," Trinity Economics Papers 994, Trinity College Dublin, Department of Economics.
  6. 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.
  7. Lane, Philip R., 1996. "Stabilization policy in a currency union," Economics Letters, Elsevier, vol. 53(1), pages 53-60, October.
  8. 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.
  9. Marion Kohler, 1998. "Optimal currency areas and customs unions: are they connected?," Bank of England working papers 89, Bank of England.
  10. Balogun, Emmanuel Dele, 2008. "An alternative reconsideration of macroeconomic convergence criteria for West African Monetary Zone," MPRA Paper 11367, University Library of Munich, Germany.
  11. 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.
  12. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, vol. 43(3-4), pages 263-286, November.
  13. Balogun, Emmanuel Dele, 2009. "Alternative reconsideration of output growth differrential for the West African Monetary Zone," MPRA Paper 13416, University Library of Munich, Germany.
  14. 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.
  15. Weber, Axel A., 1997. "Sources of Currency Crisis: An Empirical Analysis," Discussion Paper Serie B 418, University of Bonn, Germany.
  16. Marion Kohler, 1999. "Coalition formation in international monetary policy games," Bank of England working papers 92, Bank of England.
  17. 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.
  18. Lodovico Pizzati, 2000. "Monetary Policy Coordination and the Level of National Debt," Empirica, Springer, vol. 27(4), pages 389-409, December.

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