In his seminal 1960 article Robert Mundell proposed a model of balance-of-payments crises in which confidence in the continuation of a currency peg depended on the observed holdings of central bank foreign reserves. We examine the implications of a reformulation of this view from the perspective of an equilibrium business cycle model in which the probability of devaluation is an endogenous variable conditioned on foreign reserves. The model explains some business cycle regularities of exchange-rate-based stabilizations while also producing devaluation probabilities that capture some features of devaluation probabilities estimated in the data. The analysis aims to explain both the real effects and the collapse of temporary fixed-exchange-rate regimes in an unified framework, and provides an economic interpretation for the evidence that foreign reserves are a robust leading indicator of currency crises.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
7045.
Length: Date of creation: Mar 1999 Date of revision: Publication status: published as Money, Capital Mobility and Trade: Essays in Honor of Robert A. Mundell, Calvo, G., R. Dorubusch and M. Obstfeld, eds., Cambridge: MIT Press, 2000, forthcoming. Handle: RePEc:nbr:nberwo:7045
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Find related papers by JEL classification: F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F31 - International Economics - - International Finance - - - Foreign Exchange
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