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

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

The paper analyses 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 centre 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 centre 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 ERM in 1992-3.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1201.

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Date of creation: Jul 1995
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Handle: RePEc:cpr:ceprdp:1201
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  1. Stefan Gerlach & Frank Smets, 1994. "Contagious speculative attacks," BIS Working Papers 22, Bank for International Settlements.
  2. 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.
  3. 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.
  4. 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.
  5. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March.
  6. 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.
  7. Ozkan, F. Gulcin & Sutherland, Alan, 1998. "A currency crisis model with an optimising policymaker," Journal of International Economics, Elsevier, vol. 44(2), pages 339-364, April.
  8. 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.
  9. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
  10. 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.
  11. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
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