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Stabilisations, Crises and the "Exit" Problem - A Theoretical Model

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Author Info

  • Michael Bleaney

    (University of Nottingham)

  • Marco Gundermann

    (University of Nottingham)

Abstract

Exchange-rate-based stabilisations, even if successful, usually lack credibility initially. This is reflected in high (ex post) real interest rates and some degree of real exchange rate appreciation. Empirical observation suggests that wage inflation declines smoothly over time whilst interest rates are volatile. We capture this by assuming that expectations are formed adaptively in labour markets, but rationally in financial markets. The model provides insights into: the eruption of exchange rate crises after a long period of apparently successful stabilisation; the potential advantages of a heterodox approach; when to delay a stabilisation attempt; and the optimal date for ''exit'' to a floating exchange rate.

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File URL: http://128.118.178.162/eps/mac/papers/0207/0207003.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0207003.

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Length: 31 pages
Date of creation: 05 Jul 2002
Date of revision:
Handle: RePEc:wpa:wuwpma:0207003

Note: Type of Document - pdf; prepared on PC; to print on probably A4; pages: 31. based on earlier discussion paper
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Web page: http://128.118.178.162

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Keywords: credibility; currency crisis; exchange rate; stabilisation; inflation reduction; adaptive expectations; rational expectations; real overvaluation effects;

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  1. Paul R. Masson, 1999. "Multiple Equilibria, Contagion, and the Emerging Market Crises," IMF Working Papers 99/164, International Monetary Fund.
  2. 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.
  3. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, vol. 43(3-4), pages 263-286, November.
  4. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  8. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  9. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  10. Calvo, Guillermo A. & Vegh, Carlos A., 1999. "Inflation stabilization and bop crises in developing countries," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 24, pages 1531-1614 Elsevier.
  11. Obstfeld, Maurice, 1996. "Models of Currency Crises with Self-fulfilling Features," CEPR Discussion Papers 1315, C.E.P.R. Discussion Papers.
  12. Fielding, David & Bleaney, Michael, 2000. "Monetary Discipline and Inflation in Developing Countries: The Role of the Exchange Rate Regime," Oxford Economic Papers, Oxford University Press, vol. 52(3), pages 521-38, July.
  13. Rudi Dornbusch, 2001. "A Primer on Emerging Market Crises," NBER Working Papers 8326, National Bureau of Economic Research, Inc.
  14. Gregor Irwin, 2004. "Currency boards and currency crises," Oxford Economic Papers, Oxford University Press, vol. 56(1), pages 64-87, January.
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  16. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  17. 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.
  18. Lux, Thomas, 1995. "Herd Behaviour, Bubbles and Crashes," Economic Journal, Royal Economic Society, vol. 105(431), pages 881-96, July.
  19. Sebastian Edwards, 2001. "Exchange Rate Regimes, Capital Flows and Crisis Prevention," NBER Working Papers 8529, National Bureau of Economic Research, Inc.
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