Destabilizing Effects of Exchange-Rate Escape Clauses
AbstractThis paper studies the merits of policy rules with escape clauses, analysing as an example fixed exchange rate systems that allow member countries the freedom to realign in periods of stress. Motivating this example is the debate within the European Monetary System over how quickly to move from the current regime of national currencies, linked by pegged but adjustable exchange rates, to a single European currency. The paper's main point is that while well-designed rules with escape clauses can raise society's welfare in principle, limited credibility makes it difficult for governments to implement such rules in practice. An EMS-type institution which presumably imposes a political cost on policy-makers who realign may lead to an optimal escape-clause equilibrium, but may just as well lead to alternative equilibria far inferior to an irrevocably fixed exchange rate. Countries can suffer periods in which no realignment occurs, yet unemployment, real wages, and ex post real interest rates remain persistently and sub-optimally high.
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Bibliographic InfoPaper provided by University of California at Berkeley in its series Center for International and Development Economics Research (CIDER) Working Papers with number C96-075.
Date of creation: 01 Dec 1996
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Other versions of this item:
- Obstfeld, Maurice, 1997. "Destabilizing effects of exchange-rate escape clauses," Journal of International Economics, Elsevier, vol. 43(1-2), pages 61-77, August.
- Maurice Obstfeld, 1998. "Destabilizing Effects of Exchange-Rate Escape Clauses," NBER Working Papers 3603, National Bureau of Economic Research, Inc.
- Obstfeld, Maurice, 1996. "Destabilizing Effects of Exchange-Rate Escape Clauses," Department of Economics, Working Paper Series qt15n3p5dt, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- Obstfeld, Maurice, 1991. "Destabilizing Effects of Exchange-Rate Escape Clauses," CEPR Discussion Papers 518, C.E.P.R. Discussion Papers.
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