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Are Currency Crises Low-State Equilibria? An Empirical, Three-Interest-Rate Model

  • Christopher M. Cornell
  • Raphael H. Solomon
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    Suppose that the dynamics of the macroeconomy were given by (partly) random fluctuations between two equilibria: "good" and "bad." One would interpret currency crises (or recessions) as a shift from the good equilibrium to the bad. In this paper, the authors specify a dynamic investment-savings-aggregate-supply (IS-AS) model, determine its closed-form solution, and examine numerically its comparative statics. The authors estimate the model via maximum likelihood, using data for Argentina, Canada, and Turkey. Since the data show no support for the multiple-equilibrium explanation of fluctuations, the authors cast doubt on the third-generation models of currency crisis.

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    Paper provided by Bank of Canada in its series Staff Working Papers with number 06-5.

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    Length: 31 pages
    Date of creation: 2006
    Date of revision:
    Handle: RePEc:bca:bocawp:06-5
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    1. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
    2. Cooper, Russell & Corbae, Dean, 2002. "Financial Collapse: A Lesson from the Great Depression," Journal of Economic Theory, Elsevier, vol. 107(2), pages 159-190, December.
    3. Bertola, Giuseppe & Caballero, Ricardo, 1990. "Target Zones and Realignments," CEPR Discussion Papers 398, C.E.P.R. Discussion Papers.
    4. William R. White & Claudio E. V. Borio, 2004. "Whither monetary and financial stability? the implications of evolving policy regimes," BIS Working Papers 147, Bank for International Settlements.
    5. Dagsvik, John & Jovanovic, Boyan, 1991. "Was the Great Depression a Low-Level Equilibrium?," Working Papers 91-07, C.V. Starr Center for Applied Economics, New York University.
    6. Cornell, Christopher M., 2003. "Target zones, reserve crises, and inverted S-curves," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 13(4), pages 313-323, October.
    7. Alberto Bisin & Andrea Moro & Giorgio Topa, 2006. "The Empirical Content of Models with Multiple Equilibria," 2006 Meeting Papers 660, Society for Economic Dynamics.
    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. Alberto Bisin & Giorgio Topa & Thierry Verdier, 2004. "Religious Intermarriage and Socialization in the United States," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 615-664, June.
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