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Multiple Equilibria and the Credibility of the Brazilian "Crawling Peg", 1995-1998

Author

Listed:
  • Marco LYRIO
  • Hans DEWACHTER

Abstract

This paper studies the relationship between the probability of devaluation of the Brazilian real and the fundamentals of the economy for the period 1995-1998. We use a model of a fixed exchange rate system that allows for multiple equilibria and, therefore, makes possible the identification of self-fulfilling speculation. The devaluation probability is computed using the "drift adjustment method". The model performs satisfactorily in tracking monthly devaluation expectations and presents some important advantages over a simple linear regression of macroeconomic variables on the devaluation probability. We do not find evidence that self-fulfilling speculation was at work in the period preceding the Brazilian currency crisis of January 1999. This suggests that the breakdown of the Brazilian managed exchange rate system was due to the deterioration of the fundamentals of the economy.

Suggested Citation

  • Marco LYRIO & Hans DEWACHTER, 1999. "Multiple Equilibria and the Credibility of the Brazilian "Crawling Peg", 1995-1998," Working Papers Department of Economics ces9919, KU Leuven, Faculty of Economics and Business, Department of Economics.
  • Handle: RePEc:ete:ceswps:ces9919
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    Cited by:

    1. Marcin Sasin, 2002. "Predicting Currency Crises, the Ultimate Significance of Macroeconomic Fundamentals in Linear Specifications with Nonlinear Extensions," CASE Network Studies and Analyses 0224, CASE-Center for Social and Economic Research.

    More about this item

    Keywords

    Currency crisis; self-fulfilling speculation; multiple equilibria; Brazilian exchange rate system.;

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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