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Spreading Currency Crises: The Role of Economic Interdependence

  • Wolfram Berger
  • Helmut Wagner

We analyze in this paper how the mutual dependence of private sector expectations in different countries on one another influences the stability of fixed exchange rate regimes. The crisis probabilities of countries trading with one another are interdependent because wage setters react to an imminent loss of international competitiveness stemming from an increase in the crisis probability of a trading partner. If a currency crisis in one country is perceived to be increasingly likely, the probability of devaluation of its trading partners’ currencies to restore their international competitiveness rises as well. Thus, not only actual devaluations but also an increasing crisis probability may trigger currency crises elsewhere. We show that not only fundamental weaknesses but also spontaneous shifts in market sentiment may play a role in precipitating currency crises.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 02/144.

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Length: 20
Date of creation: 01 Aug 2002
Date of revision:
Handle: RePEc:imf:imfwpa:02/144
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